Another Bottoming Attempt Is Underway

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by: Clif Droke
Summary

Stock market internals are finally starting to improve.

It's still too early to call this a bottom, however.

A few more days of below-40 new NYSE lows are needed.

In Thursday's report we addressed the question, "Is this the final low?" my answer, based on the available evidence, was that it was too early to conclude the stock market spinal low is in. That remains true after Thursday's session, but the preliminary evidence is pointing to a bottoming attempt being underway. And unlike previous attempts, all the right things happened on Thursday. In this report will examine the growing likelihood of the stock market resuming its upward trend by later this month.

On Tuesday of this week the market displayed a conspicuous change in its character. In previous weeks whenever news the market perceived to be negative crossed the wire, the major averages had a tendency to sell off. This is the classic symptom of a market plagued by internal weakness. That weakness was most evident in the continuous trend of stocks making new 52-week lows on both exchanges, but especially on the NYSE. Even more disturbing was the long period of a negative new high-new low differential on the NYSE. This underscored the fact that the incremental demand for equities was too low to support a rally.

However, in the last three days the market showed a remarkable resilience in refusing to sell off on what by all accounts was bad news. Specifically, stocks mostly shrugged off the intensifying of trade war threats between the U.S. and China this week and even rallied when it was announced that China has proposed a new tariff plan in retaliation to U.S. tariffs on Chinese goods worth $50 billion after the U.S. announced a similar plan. What had changed so much since last week when negative headlines pertaining to the trade war caused major plunges in equity prices? That change wasn't in the market's fundamental outlook or any shift in perceptions about the strength of the U.S. economy. Rather, the positive reaction to bad news was the result of a shift in investors' attitudes towards future impacts of trade decisions on the stock market.

From a tape reading perspective, a market which ignores bad news is considered to be in an improving technical position. That is, strong hands are presumably coming to the rescue by purchasing oversold and undervalued stocks following the latest test of the February lows. That's the most likely explanation for the attitude shift and dramatic change in market behavior in just the last three days.

From a price perspective, after a 3-week plunge which saw the S&P 500 Index (SPX) test its early February low on Monday, Apr 2, the market has since had its best 3-day showing in almost a month. The market has rallied in the last three days and five of the six major indices have closed above the 15-day moving average on Thursday for the first since mid-March. Only the NASDAQ Composite Index has yet to accomplish this, but with four of the five major indices I track above the benchmark 3-week trend line the odds are improving that an immediate-term low will soon be confirmed.

The following graph shows the progression of the benchmark S&P 500 Index (SPX) which reflects the action of the most popular large-cap stocks. The graph shows what appears to be a classic "double bottom" pattern, which would also explain the market's recent change in behavior if we assume that informed investors are taking advantage of what they see as a successful re-test of the market's previous low in February. It should be emphasized that while this chart pattern looks like a double bottom, it's still too early to definitively call it that and assume the final low is in. Double bottoms can be deceiving and produce what are known in Wall Street terms as "head fakes." However, if the tape continues improving in the coming days like it has since Tuesday then the double bottom will soon be confirmed.

S&P 500 Index

Source: BigCharts

In Wednesday's commentary I made reference to the improvement in the stock market's internal profile, particularly in terms of breadth and cumulative volume. I also emphasized that the most critical of all signs of the market's internal health is the 52-week new highs and lows. In fact, without a meaningful improvement in the new highs-new lows it would be foolhardy to jump in and begin aggressively purchasing stocks since the odds would favor an eventual reversal of the latest rally attempt. On the other hand, if we see a few more days like we saw Thursday then there's every reason to believe that a serious bottoming attempt is underway. Further, the odds of the bull market being fully restored by later this month would dramatically increase if we see several consecutive days where fewer than 40 stocks show up on the new 52-week lows list on both exchanges (particularly the NYSE).

On that score, Thursday was a start in the right direction for this was the first day in exactly a month that there were significantly fewer than 40 new lows. It was also the first day since Mar. 14 that the high-low differential was positive, with 51 NYSE-listed stocks making new highs versus only 27 new lows. Selling pressure has dramatically shrunk in the last couple of days and if this turns into a trend by continuing well into next week, there is every reason for believing that the correction which began in late January is finally ending.

One of the most important pieces of corroborating evidence which should accompany a return of incremental demand for equities will be seen in the following indicator. Any additional improvement in the new highs-new lows from here should see the 4-week rate of change (momentum) of the highs and lows reverse its recent declining trend as reflected in the following graph. This indicator is used to show the stock market's near-term path of least resistance since it basically reflects the momentum of short-term incremental demand.

Source: WSJ

For now, though, the bottoming process has only just started and hasn't yet been confirmed according to the rules of my technical trading discipline. As previously emphasized, the most important confirmation of a bottom will be continued improvement in the market's internal structure, including leadership in the NYSE advance-decline (A-D) line, below, and a continued improvement in advance-decline volume as discussed in Wednesday's report.

NYSE Advance-Decline Line

Source: StockCharts

For now, though, traders should remain defensive and wait to see if the NYSE new 52-week lows remain low for a few more days before plunging in. A heavy cash position is still warranted until then for conservative investors.

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.