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.
There is much to be considered about the performance of the stock market so I will be as brief as I can in some sections of this article to make space in other sections where detailed commentary is required.
And to better understand the functions and limitations of my oscillator, consider that which follow:
(1) The journey of the finest sailboat ever built never travels on a straight line from Point A to a faraway Point B. No. It tracks a zig-zag course to get to where it is going. And it does that by tacking to starboard and then port alternately as the navigator makes course corrections while taking advantage of the winds that blow. But when seen from a sufficient distance, the zig zags conform to their average tendencies and the sailboat can appear to be traveling in a straight line as it sails toward its well-defined destination.
(2) The investment winds are always blowing in the stock market. And they too are on the side of the ablest navigator. The sequential short-term stock price trends vary in length and magnitude as they go up and then they go down, as they oscillate repeatedly. But their bullish or bearish "zigs or zags" rarely conform to their average tendencies as the stock market goes from its Point A toward its ill-defined Point B. That happens because Mr. Market does not (and cannot) navigate the market to keep it on a well-defined trajectory because he is a slave who obeys the multitude of different instructions he gets from investors when they enter buy or sell orders. And therein lays the crux of the problem: Although the longer-term trends reflect the sequential but oftentimes erratic short-term trends, the destination of Point B is almost always ill-defined.
(3) But because I get an updated status report on what is happening in the market when I update my workbook, I am able to make "informed guesses" about the significance of the changes taking place among 28 breadth and other indicators on a real-time basis.
And (4) most of the time my guesstimate will be ballpark correct after drawing the conclusions I draw. But, to add to the complexity of the forecasting problem, I (like everybody else) must cope with exogenous events such as the bizarre jump in stock prices on one Friday (the 22nd of January) and the surprising news coming out of Japan the next Friday (the 29th of January) which triggered bullish price action in the market even though such news merely implied the Fed may not increase the funds rate, as was its stated goal, and little else. So when surprising events such as those occur, a guesstimate like the ones I make can be wide off its mark, if only temporarily. I will have more to say about this matter below.
In order to guesstimate where the market will likely go to from where it is now, we need to know where it is now.
Regarding the Performance of the SPY and Related Indexes
The first chart shows the performance of six 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 the Guggenheim S&P Equal Weight ETF (NYSEARC: RSP); it is the pink line on the chart. All of the other indexes shown are capitalization weighted and they include the S&P 500 index (NYSEARCA: SPY), the Nasdaq 100 (NASDAQ: QQQ) and the Russel 2000 (NYSEARCA: IWM), the S&P 100 large cap index (^OEX), and the S&P 400 mid-caps (NYSEARCA: MDY).
As can be seen towards the middle of the chart, all of these barometers made lows in August at about the same time and all of those lows were tested some 25 days later. On the right side of the chart, you can see that the RSP, IWM, MDY and the S450 made new lows in recent days. The SPY, QQQ outperformed the equal weighted indexes for the last 60 days because of their index weightings, and the ^OEX (large caps) outperformed the MDY (mid-caps). I will have more to say about most of these indexes (and especially the ^OEX) later on in this article.
Much of the price action shown on a chart like the next one is difficult to read because many of the price lines are bunched up and/or overlapping. That should not be a problem because the main purpose of such charts is to show the few groups that are the strongest or the weakest performers, and not to highlight the many bunched in the middle.
Don't be fooled by the surge shown for the QQQ during recent months (the black line on either of the first two charts). That was not caused by a plurality of its 100 stocks doing well. No, the 15 stocks listed in the legend of the chart account for about 51% of the QQQ's value because they are heavily weighted. The surge was caused entirely by the strength in only six such stocks:
Those being Amazon (NASDAQ:AMZN), Facebook (NASDAQ:FB), Intel (NASDAQ:INTC) and the "A" and "C" classes of Alphabet (NASDAQ:GOOGL) and (NASDAQ:GOOG), and Starbucks (NASDAQ:SBUX). Had it not been for them the QQQ would not have exceeded its high made about 100 days ago. That is not a trivial conclusion because if the QQQ's "meaningful top" on its price chart is behind us at this point in time, then, until proven otherwise, its bottom must be in front of us. And as can be seen, those self-same indexes declined sharply in recent days as they led the QQQ lower.
As shown in the next chart, much of the strength that you saw in the SPY and IWM indexes in recent days was caused by "the double counting effect" of the larger cap stocks in these weighted indexes. The 20 most heavily weighted stocks in the SPY (that's 8% of the 500 stocks) account for about 31% of its price value.
And don't be fooled by what you may have seen happening in the SPY this week. On Thursday, the 28th of January, for example, the SPY was up 0.54% while the RSP was only up 0.16%. And the ^OEX (100 large caps) was up 0.93% while the MDY (400 mid-caps) was only up 0.04%. This pattern of outperformance by the large caps occurred frequently during recent months. When the equal weighted indexes consistently underperform their weighted counterparts and the mid-caps underperform the large caps, that shows speculative interest in the market is waning and such has bearish implications for the market.
And since we are now dealing with the performance of groups of stocks in the market to get an overview of what has been happening in the market, we may as well take a look at the chart below which shows the performance of 24 industry groups included in my workbook.
The RSP is the bold black line on the chart. Like all of the groups, it is an unweighted index so the chart accurately shows which of the groups are outperforming or underperforming the market because of the apples to apples comparisons. With capitalization weighted index such as the SPY, that would not be true. About half of the groups outperformed the RSP during recent months while, of course, the other half were underperformers.
The 50 level (shown by the dark red hashed line) is the dividing line for showing which groups are priced above or below their respective price levels during a 22-day base period existing six months ago. At the present time, none of these groups is priced above that level. And those groups that managed to rise above their highs, as indicated for the base period during recent months, are now well below those highs. So this chart also shows that the highs for each of these groups could be behind us and, if so, their bottoms could and may be in front of us. The numbers attached to the names of the industry in the legend list the number of stocks included in that group.
With what has been stated above as prologue, let's see where this analysis goes from here.
Documentation by the "Sobon Oscillator"
Let's see if I can shed light on the stock market's never-ending mystery: "Where is it going to go from where it is now?" I will (1) explain the salient features of a few sequential short-run time spans relating to the stock market's performance during recent weeks, and then (2) guess what such may signal for the near- to longer-term future as the market trends toward its ill-defined goal.
To provide perspective, let's start by going back three weeks to the four-day work week ending with Friday, the 22nd of January.
But to facilitate understanding of the tricky analysis relating to the oscillator, let's quickly review what the many variables shown in the four panels on its chart are all about:
(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 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 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)."
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 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 three short-run time periods framed by the different colored boxes on the chart. The section on the right side of the chart (the brown box) shows data relating to the week ending Friday, the 29th of January, will bring us to the cutting edge of the future.
We begin with Monday, the 18th of January (the pink box; the small white box added to this and the other larger boxes were meant to call attention to price changes and related volumes because of their special importance at this time). The stock market had been trending downward and such continued on Monday. In retrospect, it was abundantly clear that the sharp increase in stock prices on Friday, the 22nd of January, was unpredictable because it was not forecastable (except perhaps by insiders who may have known what the consequences of their actions might be).
(1) After the market closed on Friday (the blue box), I updated my workbook like I normally do at that time each day. And when I looked at the changes made to the 24 breadth and other indicators included in the oscillator, it took me less than a minute to know that something of a suspicious nature occurred and it didn't pass my "smell test." Analysis of the changes made in all of the indicators requires me to have an explanation for every change that occurs each day. So it was only natural for me to search for an answer to the problem I detected. And after further investigation, I was sure that we would not get a bullish performance in the market on Monday, the 25th of January. Why?
(2) Friday's moderate volumes of trading in the SPY, QQQ, and IWM didn't correlate with the large price gains in those indexes. The volume of trading relating to my S450 index did correlate with its price change because of the way I use index numbers to accomplish that feat. So I suspected that the trading volumes for the SPY, QQQ, and IWM should have been much greater than they actually were.
And (3) after further consideration I concluded that there was much that was artificial about the strength in the market that day so I posted comments to my article explaining the matter while concluding that the market would be flat to down when trading resumed on Monday. That opinion proved to correct. Case closed.
During the week ending Friday, the 29th of January (the blue box), the market was down sharply on Monday as I speculated it might be. It was up on Tuesday and down on Wednesday with the price-change data and the trading volumes correlating about as they should. But then on Friday the news out of Japan triggered the surge in buying that resulted in price gains for all of the price-change indicators rising by at least three times what I call the "neutral norm" and the advance-decline for the 450 stocks in my S450 index was a lopsided 93% in favor of the advances. Considering that this was largely a one-way market movement, the volumes of trading were about right for the kinds of gains being scored in the market.
I had been targeting a drop from 192 to 173 for the SPY during the near- to longer-term future (to me that time span ranges from one week to a couple of months). It was headed in that direction until the bizarre price gains occurred on Friday, the 22nd of January. And then there came the 4% gain in the SPY on Friday, the 29th of January, that resulted from the surprising news that came of Japan and lifted the SPY to 193.70 on its price chart.
Some people see something like that happen, shake their heads and conclude that the stock market cannot be forecasted effectively. But a surprising event can never be forecasted, because if it could be, it wouldn't be a surprising event. It is what happens unexpectedly in the market when a surprising bullish or bearish event occurs that makes the market difficult to forecast. Of course, if someone is ill-informed about what is going on in the market, then anything of significance that happens will be a surprising event. Sages have long advised that if you want to divine the future, study the past. And that is what I do when I frisk the data processed through my oscillator.
Although day-to-day prices changes may not be predictable with a high degree of reliability, I maintain that short-term trends can be anticipated. I am not a day trader. I average less than three trades a month as I try to trade a short-term trend indicated by the oscillator. Obviously, my guesstimate of a drop in the SPY to 173 was wrong. But, it was wrong for the right reasons and such can be compensated for. In my personal trading account, I had a nice gain going in a 3X leveraged and inverse ETF position I initiated a couple of weeks ago. Because of the surprising strength in the market that took place on those two Fridays, my paper profit disappeared and I was stuck with a nominal loss in that position. However, during the week ending with the 5th of February (the brown box), the price action was decidedly bearish. On Monday, Wednesday and Thursday, the price-change data was modest or even erratic among the major ETFs, even though the related volume of trading was greater than the norm. But on Tuesday and Friday, the prices of the ETFs were sharply negative on heavy volume, indicating that the selling being done was being done with conviction. So now I show a profit in the aforementioned position.
The SPY closed the week at 188. In a previous article in this series I stated that if the ^OEX index (large caps) started to underperform the market it would be "Katy bar the door" for the market and the SPY could drop well below my target of 173. The recent price action in the SPY, QQQ, IWM and the ^OEX show that the large caps did in fact lead the market lower. That leads me to believe that the SPY could drop well below the 173 level. But until such time that it gets nearer to 173 from its current level of 188, I am going to stay with my target of 173. If other contributors to Seeking Alpha want to make more aggressive forecasts as to how low the SPY could go, I would not argue against their point of view.
Eric Parnell wrote an article that was posted by Seeking Alpha on Friday, the 5th of February. Its title was "How Long Will the Next Bear Market Last." In his inimitable way, he made a historical study of bear markets and concluded that, "If a typical major bear market lasts 30 months on average from peak to trough, it is likely that the next major bear market will last much longer, perhaps twice as long or more, as the market's long overdue need to cleanse the system is resisted by repeated rounds of policy intervention to try and stop the bleeding along the way." And, he believed "The next bear market is one that could bring declines in excess of -30% or -50% or more." That would drop the SPY from its current price of 188 to about 115, give or take some 15 points. I think a ballpark number like 115 is plausible.
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 international economic l 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. It just adopted a negative interest rate policy. 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). Mario Draghi may soon do something just as stupid in Europe. 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.
Add to that the fact that a contentious political campaign is underway. The citizenry wants change. And the Republican Party is in disarray. In his classic "An Essay on Politics," Ralph Waldo Emerson wrote that when the citizenry is ready for change, it will occur one way or another. During the revolutionary war of 1776, Tom Paine galvanized the colonists to fight for their rights with his book called "Common Sense." And then, at the behest of George Washington, he wrote his "Sunshine Soldier" poem. Washington and Jefferson agreed that the revolution would not have succeeded without the contributions made by Tom Paine. Bernie Sanders may be the Tom Paine of our times. He may not become a presidential nominee, but he is raising issues that are certainly enlightening the common people in this country. We won't know what the outcomes of the upcoming elections until November. It would be a very long-shot proposition, but if anybody can do something to bring about changes in the leadership of the Republican controlled the House and Senate, Bernie may be the man to do that. If such should happen, the effects on the stock market might not be bullish. This is another unquantifiable risk that investors should be aware of.
From 2008 until the beginning of 2015, the correct strategy for investing in the market was to "buy the dips." Going forward, I think the correct strategy will be "sell the rallies." Investors who have a buy and hold strategy ought to reconsider the merits of that philosophy for managing their money because they may have to cope with down or at best narrow trading ranges in the market for some time to come. Traders, however, could find that the volatile nature of such an investment environment can provide an abundance of opportunities to ply their trade. And the use of inverse ETFs could be a way to hedge one's general stock market risks when he is exposed to such while holding long positions.
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.
The only judge and jury that I must answer to is Mr. Market. He can be as deceptive, specious and misleading a hombre one can encounter. But he is also the unbiased arbiter of who wins or loses in the market. Whenever I am wrong that will be made manifest and I will sustain a loss in my personal investment account. But if I am right, I will then have tilted successfully with him and likely show a profit from my trading activities.
If and when I believe that writing another updated article in this series would be the prudent thing to do, I will write it. Until then, I wish to thank the readers for taking the time to read my articles, and especially those who commented on the subjects about which I wrote. Best wishes to all.
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.