The Die Is Cast: My 'Guesstimate' For A Downtrend In Stock Prices Is Now 'Confirmed'

| About: SPDR S&P (SPY)
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Look out for falling stocks.

The 'confirmed trends' component of the 'Sobon Oscillator' shows why (1) the market's top is behind us and (2) the trend will now be down.

Technically, the chart pattern for SPY shows it could drop from 204 and test its low of 183 made on February 11, 2016. That would be a decline of 10%.

Now that the oscillator's declining long-term-trend indicator turned negative, erosion and then a waterfall drop in stock prices could occur (like that which happened last August).

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.

Because I will be making comments (near the end of this article) about the merits of speculating in leveraged inverse ETFs related to the SPY, QQQ and IWM ETFs, I suggest that interested readers pay close attention to the ways the widely followed market indexes have been trending. Such will be discussed in the next part of this article.

There are five component parts (and some 35 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" which are derived from 450 equally weighted stock price trends. The most significant of four confirmed trends is the "Long-Term-Trend Indicator" (the acronym for which is LTTI). I get to choose which of the five component parts I want to emphasize when finalizing a conclusion.

In recent days, the feedback that I got from all five of these components was bearish. And I could have made a "guesstimate" based upon the first four components listed above. But I chose to base my decision on the fifth component, with the emphasis being placed on the LTTI. The other four component parts will not be charted in this article. They may be referred to, but they will not be discussed in much detail because such would be superfluous.

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.

The chart shows the performance of seven well-known ETFs during the 150 days. 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 index (NYSEARCA:RSP), the black line on the chart. The other equal-weighted index charted, the NASDAQ 100 (NASDAQ:QQEW), is the light green line.

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

Because SPY is widely considered to be the most important of all market barometers, I use it to be the benchmark indicator for the general market. The hashed orange line on the chart is the 150-day high for SPY.

All of these market indexes bounced off the bottoms of their price charts in February. That was 69 trading days ago as framed by the white box. However, some did so more dramatically than the others and therein lays one of the keys 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 other key to understanding the market's performance relates to the decline in stock prices since the rally reached its peak 16 days ago. Some major companies... one of which was Apple (NASDAQ:AAPL) while others were retail or technology companies ... reported earnings reports that disappointed the investment community. Also, announcements by Fed officials indicated that an increase in interest rates could occur sooner than the Wall Street crowd wanted. The announcements came as a surprise and yields on Treasury issues increased while stock prices declined.

The chart shows that most of the indexes performed well during the bounce: but (1) SPY was outperformed by RSP because (2) the mid-cap stocks such as those in MDY outperformed the large-cap stocks like those in ^OEX. The market showed weakness during the last 15 trading days, but these four SPY related indexes did significantly better than the other indexes being discussed here.

(3) QQQ and QQEW were laggards during the bounce when compared to SPY. QQQ is lopsidedly (insanely?) weighted with large-cap stocks (the top six stocks in the index account for 36% of its value). There have been times during the past year when only six of these stocks made the index out- or under-perform SPY for weeks at a time. The recent price weakness in Apple and a few other stocks took their toll and caused pronounced weakness in QQQ. It and QQEW are now underperforming all of the other indexes shown in the chart. Since I have no confidence in using QQQ as a reliable market barometer, I rely upon QQEW for perspective on the performance of stocks in that index

(4) IWM also bounced, but it lagged the performance of SPY. But with 2,000 stocks in the index (many of which have no tangible earnings and/or don't pay dividends), it is difficult to gain an understanding of what the fundamental investment merits are for those stocks.

(5) My Tech43 index matched the strong and bullish performance of RSP up until 15 trading days ago. Following the lead of technology stocks like Apple, this index showed "pronounced weakness" as some of its component companies reported poor operating results. This augurs ill for Tech43's near-term performance. It had outperformed all of the other indexes referred to above for more than two years.

(6) My S450 index 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 QQQ and 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 breadth indicators I will emphasize when finalizing a conclusion: (1) if I see that trend-changing developments are occurring in any of the four component parts of the oscillator, I could use that feedback to make a "guesstimated" decision about the market's indicated trend. Or (2) I could defer 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 one shown above with a few items 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 (3) the white box frames what happened in the market since it began to trend up and then make its high 16 trading days ago. And (4) the table to the right of the chart and referred to as LTTI #1 shows 25 days of closing daily values for LTTI, which is the main item among the "confirmed trends" indicators.

According to the oscillations shown in the panel, the current "long-term cycle" started when (1) the market went down to make a trough in August 2015 and then (2) it went up to make a peak at the end of April 2016. That entire time span framed by these boxes lasted 120 trading days (that's about six months). And now I expect the stock market to go down to make another trough. Why? Consider that which follows:

The LTTI (Long-Term Trend Indicator) 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 the crossover cycle, the more volatile it will be). These shorter cycle indicators lead the LTTI to where it is 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; and being proprietary, that is something which I will not explain here).

As crossovers, the short-, medium- and long-crossover breadth indicators (the bottom panel oscillate the way that each does and generates its own cycle). As can be seen on the far left side of the panel (1) they weakened and then led the LTTI down from its near-maximum high of 86% (with 100% being the maximum). 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 lowest 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 (as can be seen on the right side of the pink box) and they went down to test their then 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 (as shown in the white box) to reach a high of plus 94% about 16 trading days ago.

(4) Since then, all of these breadth indicators trended lower and the LTTI now shows a value of minus 22%. Let's consider the meaning of that negative number: (1) it is the difference between the percentage of breadth indicators in the LTTI series that is strong minus the percentage of such indicators that is weak. So (2) a reading of minus 22% means that 39% are strong, but 61% are weak. And (3) the trend is clearly down so the LTTI is indicted to get more bearish and certainly not more bullish because there is no evidence among the short-, medium- or long crossover indicators that the downward trend can possibly be reversed in nearby days... Furthermore, (4) the other four components included in the oscillator (they deal with price changes in the major market indexes, the volume of trading in such, new highs and lows and strength or weakness in moving averages) have bearish indications. If I wanted to use them to justify a bearish guesstimate about the outlook for the market at this time, I could have done so. But because the confirmed trends gave very explicit signals regarding the market's trend, I decided to use them.

(5) Inasmuch as the LTTI is now below the zero line, the market is vulnerable to a waterfall drop in stock prices (such as that which occurred in August).

(6) There could be a short-term relief rally (such as that shown by the performance of the three crossovers on the left side of the pink box), but the LTTI is so strongly negative that the rally would fade quickly (just as it did last August).

In conclusion (7) I am not going to put a number on how low SPY could go. When you start making arbitrary guesses 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 I showed in the boxes on the chart how that can be done. I will stay with the trend indicated by the LTTI until such time there is sufficient reason for me to believe that a change in the trend is probable.

Right now, the market is indicated to go lower. Technically and according to its price chart, SPY could drop from its current price of 204 to test its low of 183 made on February 11, 2016. That would be a decline of 10%.

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 provide life support for the economy (and the stock market) by benefiting 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 such here.

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 leveraged inverse ETFs.

The chart below shows the performance of three popular 3x leveraged inverse ETFs related to SPY, QQQ and IWM for the last 150 trading days (also shown are the related price lines for the market indexes and the confirmed-trends component of the oscillator that were shown above). In addition, it shows the performance of VXX. These speculative investment vehicles should only be used by speculators (gamblers?) who understand and are willing to accept the trading risks involved.

These ETFs are volatile, and they were often erratic and only performed well when the market decline was accelerating toward its bottom as shown in the pink box. At other times, traders would have had to time their purchases and sales with near perfection to make a profit. During the recovery phase of the long stock market cycle (as shown in the white box), these ETF prices were all in declining trends. At the present time, only SQQQ has been making some upward progress. That is because QQQ was doing so badly. If and when opportunities present themselves, I expect to be a trader of some of these speculative vehicles.

If any reader is interested in trading inverse ETFs, I suggest that he learns whatever he can about them now. Luck is the thing that happens when preparation meets opportunity. By understanding the pros and cons of speculating in them and learning how they can be used for speculative purposes, he may get lucky and be able to take advantage of unusual trading opportunities as they present themselves. But such opportunities have to be cheery picked and that is not a very easy thing to do.

Since the breadth indicators in my oscillator are more closely linked to SPY than they are to QQQ or IWM, I have a better understanding of the 3X inverse ETF (NYSEARCA:SPXS) linked to the SPY than I do of those SQQQ and SRTY, which are linked to QQQ or IWM. So any trading I do will likely be in SPXS, but I have traded SRTY before. At the present time, I have a trading position in SPXS. Such trades usually last a few days. I don't intend to trade SQQQ because of the lopsided way that a few heavily weighted stocks can wag QQQ. The volatility index [VXX] has been the weakest performer among these ETFs. I don't believe the timing is right for taking a trading position in it at this time because its price chart shows that it lacks a base from which a sustainable advance can be supported. Perhaps a saw tooth pattern will occur in nearby days and establish such a base. But if and when the timing is looks right, I expect to trade it.

Timing purchases and sales of these speculative vehicles is of paramount importance. And readers will have to develop their own strategies for doing such. The rewards for trading them successfully can be spectacular.

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. But it is up to them to make their own personal investment decisions.

Disclosure: I am/we are long SPXS.

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.