Revisit #2 To 'The Stock Market Correction Is Underway'

| About: SPDR S&P (SPY)
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In this article I will update readers about the feedback I got from the Sobon Oscillator,.

I will conclude once again that the SPY will go down by at least 10% from its current level of 188.

And I will explain why a more substantial drop is possible.


This is the second revisit to my article called "The Stock Market Correction Is Underway" (dated January 6, 2016). During the three days ending on Friday the 8th of January, the drop in stock prices was broad based and substantial. And it was necessary for me to update that article because (1) I had more information to add and bolster my bearish case and (2) I became more bearish on the stock market than I had been. So I wrote a follow-up called Revisiting "The Market Correction Is Underway," which was posted on the 10th of January. And now, for reasons that will be made clear below, it is necessary for me to post the second updated article.

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 work that I do. So wherever you see multiple lines on a price chart or bars where trading volume data is shown, the performance of one line or bar is comparable to any other such thing among stocks because the raw data relating to all them was converted into index numbers before the chart was constructed.

Regarding the Performance of Selected Stock Indexes in the Market

The chart below is an expanded version of the one that was posted in the January 10 article. As before, it 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, the RSP (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), the S&P growth (NYSEARCA: IVW) and value (NYSEARCA: IVE), the Nasdaq 100 (NASDAQ: QQQ) and the Russell 2000 (NYSEARCA: IWM).

In the last article I called attention to the "bubbly" price action in the QQQ as shown by the green line on the chart above. A few days after the article was posted, I wondered about that so I did some research and concluded that the QQQ was a "pig in a poke" and I could not get reliable feedback by tracking its performance. The "bubbly" price action did not happen because a plurality of the 100 stocks in the index showed strength in their prices. No. It was due primarily to the price action of just five of the 100 stocks included in the index. Those being Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), Intel (NASDAQ:INTC) and the "A" and "C" classes of Alphabet stocks, (NASDAQ:GOOGL) and (NASDAQ:GOOG). All of them are heavily weighed compared to most of the other stocks in the index. And were it not for the surge in the prices of those five stocks during the past 40 days (especially that in AMZN), the QQQ would not have exceeded its high made in July 2015 at 114, as it recently did. Because of the lopsided (in my opinion) weightings of the top 10 stocks in the QQQ, they account for almost half of its market price. If so few stocks can affect the performance of the QQQ that much because of their weightings, it is not a very good barometer for indicating group performance. Therefore, I no longer consider it to be a reliable index for providing perspective for technology and other assorted big cap stocks. As a replacement for the QQQ, I am now using my index of 45 unweighted technology stocks. Its performance is shown by the purple line on the chart above. About 20 days ago it made another new high. And during many of the last 30 days, it price was higher than its high made in July. In the chart's legend it is referred to as "Teck45." Its price action clearly shows that it has been a consistent outperformer of the QQQ. And knowing what I now know about the QQQ, this will be a significant upgrade in the quality of the market barometers that I follow on this chart. But that is not the main reason why I wrote this update.

In my last article, I stated that the market "would go down to at least test the August lows." And "if the SPY breached its low, it had at least 10% further to go on the downside." It is at the August low level right now. On the left side of the chart above you can see where those lows were for all the indexes. And on the right side of the chart you can see that half of them (notably the Russell 2000 and the S&P mid-caps, the RSP and the S450) have already broken below their August lows while all of the others could easily do so very shortly. The blue box on the chart frames the price action that occurred during the last 22 trading days. The commentary that follows will be focused almost entirely on those days.

Documentation by the "Sobon Oscillator"

Let's see what can be gleaned from what is shown in the next chart, with emphasis placed on the price action beginning with January 2 (the blue box) and the next section of the chart that is not defined by a colored 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).

To facilitate understanding of the analysis that follows, let's first consider what the many variables shown in the four panels on the chart are all about:

(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 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, (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 the SPY's capitalization weightings). The time spans for the eight series of highs or 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 happens during sequential short-run intervals, let's consider what happened during the three short-run time periods framed by the different colored boxes on the chart.

To put today's situation in perspective, let's begin by reviewing what happened in the market during the week 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 was 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 (if such was to occur) that "bad news had already been discounted". Spinning the news is something the establishment (the big brokerage houses, the money center banks, the large institutional investors, and prominent investment advisors) does masterfully well. The market was up slightly on Monday (this data is not shown because the 22 day period started the following day) 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, there was the tax-loss selling season. What there was of the "Santa Claus" rally didn't amount to much and may have been trumped by tax-loss selling considerations. The oscillator ended the year showing weakness in all of the short-term breadth indicators but that could 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.

So far, explaining what was happening in the market was easy. But stock market dynamics are complicated and what follows involves much that is complex. There is no easy way for me to explain that because there are many moving and interrelated parts here and they must be considered in their entirety to get a comprehensive understanding of what is going on in the market. And knowing which indicators are weak is just as important as knowing which indicators are strong. Without such an understanding, it is difficult (if not impossible) for me (or anyone else) to make a meaningful forecast about how the market will trend during the near- to longer-term future. To me, the near-term future always begins right now and could last for several weeks. The longer-term begins after that and lasts (many months or possibly years) until it becomes necessary for me to change my latest stated opinion about the market's short- to longer-term trend. So let's see what more needs to be said about the subject being discussed as I continue with my dissertation beginning with the first day of trading in 2016 (the blue box).

On Monday (Jan. 4) the market declined sharply so it was probable that the selling pressure in the market during the final trading days in December was not due entirely to yearend 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 as I start with Monday and also deal with action in the market for the entire week.

(1) The price-change data 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 the second panel. The same thing can be said for the three days ending with Friday, the 8th of January. So the selling being done was done with conviction.

(2) The breadth indicators for the moving averages (the bottom panel) 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 must lead the others) showed a reading of -92%. 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 each showed that -84% of their related stocks were weak. All of the longer-term breadth indicators were also following suit and each of them showed a reading of -72% for the stocks in their respective moving averages. So, obviously, the stock market was weak and weakening and there was nothing to indicate a change was likely anytime soon.

And (3) the breadth indicators for the highs or 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, which showed that the S1 was in fact leading the S4 lower. The longer-term breadth indicators for the highs and lows were also following suit and they ranged from -69% for the L1 to -30% for the L4 as they were being led lower. This confirmed the conclusion that the market was weak and weakening and there was nothing to indicate a change was coming.

The only conclusion that I could draw from what started on Monday and continued through Friday as shown by the oscillator is that the momentum in the market was broad based and decidedly bearish. And, therefore, the market would probably go lower during the near-term future. How low? The SPY is widely regarded as the benchmark indicator for the market. My guess was that it could drop another 10% from its then current price of 192. That would take the SPY down to 173. It is currently trading at 188. But, I will qualify that bearish guesstimate by making some statements about the ^OEX, and that I will do later on in this article.

That brings us to Monday, the 11th of January and the section on the right side of the chart without a box around it. On Monday and Tuesday an attempt was made to rally the market as shown by the heavy volume of trading in the indicators shown on the second panel on the chart. Although the buying interest was almost twice the "neutral norm" (that is my term and illustrated by the dotted lines on the panel), the price changes in the indexes (the first panel) were either mixed or tepid. That indicated there was overhead resistance (meaningful supply ready to be sold) in the market. During the next three days ending with Friday the 15th of January, the market was down sharply on very heavy volume on Wednesday, up sharply on Thursday and down sharply again on Friday, the 15th of January.

The shortest of the short-term breadth indicators (the S1 shown on the bottom panel) for the moving averages, was choppy (reflecting volatility) during the week but at no time did it give a plus reading. All six of the other related indicators barely budged, showing that their negative readings remained unchanged. And that was a bearish signal for the market, illustrating that what doesn't change on the chart can have significant meaning.

The breadth indicators for the highs or lows are more sensitive than those for the moving averages. Although the short-term items were choppy during the week, at no time did they give a significant plus reading. In order for the SI indicator to signal the beginning of a directional change in the market, it usually shows a swing of 50% or more from the previous day's level as it goes from negative to positive one day (or vice versa when the reversal is downward) and then shows a further gain the next day. The changes the S1 showed on the chart during recent days didn't come close to doing that, illustrating again that what doesn't happen on the chart can have significant meaning.

The only meaningful conclusion that I can draw from the performance of the market during the week is that nothing has happened among the breadth indicators to change the bearish reading it signaled previously when the negative reversal of trend first occurred. In fact, the current negative signal was bolstered by the failed attempt at a rally on Monday and Tuesday which was followed by the gyrations in stock prices on heavy volume during the three days ending on Friday. My guess is that the SPY could drop another 10% from its current price of 188. That would take the SPY down to 169. And that is my guesstimate at this time.

The chart below shows the performance of 24 industry groups included in my workbook. Much of the action shown for them is difficult to read because many of the price lines shown are bunched up and/or overlapping. That should not be a problem because the sole purpose of the chart is to show the few groups that are strongest and/or the weakest performers, and not to highlight the many bunched in the middle. The 50 level (shown by the yellow hashed line) is the dividing line for showing which stocks are above or below their levels during a 22-day base period existing six months ago. At the present time, none of these groups is priced above that level. The RSP is the bold black line on the chart. Like all of the groups, it is an unweighted index so it clearly shows which of the groups are outperforming or underperforming the market.

The oil refiners, Reits and technology stocks had been strong performers but during the last few weeks they faltered. The weakest performing groups include industrial metals, MLPs, oil producers and oil service companies, and the gold producers (in that order). You can see from the weak price action for all 24 of the groups during recent weeks were pervasive. 100% of the data used to construct this chart was also processed by the oscillator. But that 100% only accounts for about 70% of all the data processed by the oscillator every day it is updated. What you see on this chart illustrates what the oscillator is capable of discounting as it renders it readings for the breadth indicators referred to above.

I stated above that I would qualify my guesstimate regarding the near- to longer-term future of the SPY by making some statements about the performance of the ^OEX. And that is what I will do at this time: The big-cap stocks have much to do with the performance of all capitalization weighed indexes as shown by the statements I made above regarding AMZN, FB, GOOG and INTC. 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 on a relative to mid- or small-cap stocks. So don't be fooled by their apparent strength on price charts because such indexes are distorted because of the weightings (which are a form of double counting) when compared to the performances of individual stocks; and, therefore, their performances on the charts conceal as much as they reveal.

In recent days the weakness in the ^OEX (as was shown by the price-change data in the top panel of the blue box) shows the big-caps declined sharply along with the others. Although I didn't include such in this article, my workbook data for the ^OEX shows that at 842 it is now 9% below its record high of 938 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 SPY and it will drop much more than 10% from its current price of 188. I am not going to put a number on how low the market could go because there is no one (unless he is clairvoyant and also has infallible crystal ball) who can possible know that. But I can say with conviction that the potential downside for the SPY could be well in excess of 10% from its current price level of 188.

In the January 6 article I wrote extensively about the performance of economy, the sophomoric policies of the Fed, the irresponsible behavior of the do-nothing Congress, and the political campaign underway. And I stated that "Things endure according to the amount of virtue they contain. And there wasn't much that was virtuous about the performance of the Fed, Congress or corporate America before and after the fiasco of 2007-2008." I did not intend to write anything about that when I started to write this article. But having written what I did thus far, I am compelled to provide comment on such matters. The next paragraph was extracted from the January 6 article:

"Because of the economic and political risks involved, investors should not be sanguine about the future course of the stock market. History has valuable lessons to teach. And it shows that after the very strong performance of the stock market during the 1960s, it declined sharply throughout the 1970s as it offset more than all of the gains made during the 1960s. And if the Fed keeps fiddling around with low interest rates as it caters to the wishes of the Wall Street community while the do-nothing Congress fails to address the political problems extant, the likes of Paul Volker may once again be called upon to initiate action and right what is wrong with a difficult economic situation. That could easily trigger troublesome conditions similar to those that existed in October of 1979 when interest rates on government backed securities got as high as 15.5%."

Furthermore, the next chart shows what has been happening in stock markets around the world.

When Ben Bernanke began and then continued to use his unproven QE theory, he gave the idea respectability and it gained traction with central bankers around the world. The idea was adopted by many of them who followed his lead. At the present time, there isn't one really strong economy among all the industrialized nations. We may even have an economic international house of cards on our hands at this time. The chart shows what has been going on in foreign stock markets. It includes Australia, Canada, Germany, China, Japan, Spain, England and France. The economies in all of those countries are weaker than that of the United States. Japan is a country poor in natural resources and it has an aging population. It also has to export goods to pay for its much needed imports. Officials there have been using QE policies based on steroids. And the imbalances QE caused in the United States are also being cause in Japan. Its stock market and those in the other countries are weaker than ours (as measured by the performance of the SPY). There is an "unquantifiable risk" that trouble could occur during nearby years which may be beyond anything we can reasonably imagine at this time. And investors should take that into consideration.

I close by saying that every investor should think long and hard about the risks he is taking in the stock market. Because the stock prices extant could have a long way to go on the downside during nearby years. With the economic and political problem extant here in the United States and the economy on life support provided by the Fed, the upside to the market in coming years, if any, can't be all that great.

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.