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The Week Ahead: A Replay of 2011 or 2012?

Posted by on Aug 22, 2015

The Week Ahead: A Replay of 2011 or 2012?

The stock market bulls finally threw in the towel last week as the selling accelerated from the opening last Thursday and was heavy into the close on Friday. The sideways trading over the past three months appeared to have been a tug of war between the bulls and bears.

As I have been pointing out since early July (Greece Isn’t The Real Problem) investors should have been worried about the technical deterioration not Greece. The uptrend in the major averages was accompanied by a downtrend in the A/D line which was a sign that just a small number of stocks were pushing the market higher.

after last week how much more can stocks decline before the correction is over?

The Markets

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The sharpest correction in the current bull market occurred in 2011 as the selling was exacerbated by the debt ceiling crisis and the downgrade of US debt. The stock market had turned higher in September of 2010 as the weekly S&P 500 A/D line had started a new uptrend by moving above the previous highs (point 1).

The weekly A/D line stayed well above its rising WMA until June 2011 as the Spyder Trust (SPY) rose from $102 to a high of $127 in May 2011. The S&P 500 A/D line dropped below its WMA in early June and stayed below it for five weeks. In late June and early July, the market rose sharply taking the SPY just a point shy of its previous peak.

Two weeks later, the SPY closed at a slightly new rally high but the A/D line formed lower highs, line b. On Friday, July 29, the A/D line dropped below its long-term uptrend and its WMA (line 2). The following week, the SPY opened above $122 but closed the week just above $112, a drop of 7.1% for the week. The weekly A/D line stayed below its WMA until early October, point 3.

The decline from July through October was preceded by a sideways pattern of the daily A/D line in both February-March and May. These periods resulted in corrections that dropped the SPY by 8% and 7% respectively. When the weekly A/D line dropped below its WMA on July 29 the market was therefore more vulnerable. In the next seven days the SPY dropped from its close of $120.84 to a low of $103.03. which was a decline of over 14%.

On October 4, the SPY made its final low of $100.91 in early trading before closing the day higher. Five days later, the daily A/D indicators confirmed that a bottom was in place as I wrote at the time in Be Bold, Be Fearless.Buy the Dip.

From the 2011 lows, the weekly NYSE Advance/Decline began a clear new uptrend and stayed above its WMA from the start of January until May 11 2012 when it dropped back below its WMA. At the time, the markets were also nervous about the Euro debt crisis and what countries might be forced to leave the Euro Zone.

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The weekly A/D line made a new high the last week of April before reversing two weeks later and dropping below its WMA on May 11 (line 2). By then the daily A/D line was already below its WMA and had also violated the April lows (line c). This confirmed the new downtrend. The decline lasted another fifteen days as the S&P 500 formed a doji on June 4, and the next day, a HCD buy signal was triggered.

The A/D line did not make a new low in early June, line d, forming a bullish divergence. The bearish sentiment was quite high at the time and in the June 6 column, Rally Potential That Bears Don’t Expect, I also pointed out the bullish divergences in the McClellan oscillator. The rally from the June lows lasted sixteen weeks as the S&P gained 16.4% from low to high.

In 2012, the first wave of selling resulted in a 8.5% decline in the SPY while by the June low the SPY had lost 10.2%. So where do we stand now?

As of Friday’s low the SPY has lost 7% while the Dow Industrials is already down 10%. Therefore a 10% top to bottom correction in the SPY may be a bit optimistic. In any case we should see a rebound in the next week and then another decline where signs of a tradable low could emerge. Alternatively we will see another 2-4 week period of sideways trading before the market sees a further decline. This is what happened in August and September of 2011.

A decline in the SPY back to the $192 area would be a 10% correction that would cause a very sharp drop in the already low bullish sentiment. However a 15% decline would take the SPY to the $182 level and I am sure would convince many that we are in a bear market.

The Economy

There is a close correlation between bear markets and recessions as stocks generally top out before the economy officially enters a recession. An important part of my market analysis is to follow a number of economic indicators. My favorite is the Conference Board’s Leading Economic Indicator (LEI). It is a composite of ten fundamental indicators and is reported monthly.

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As the excellent chart from www.dshort.com demonstrates, it has a good record of peaking out well before economy enters a recession. My analysis indicates that the NYSE A/D line typically peaks out well ahead of the start of a bear market. Last week the LEI declined slightly but it will take several more months of lower readings before one could conclude that it has topped out. The A/D line has not yet formed any significant intermediate term bearish divergence suggesting it is too early to look for a bear market.

Overall the economic data has improved this summer but there still needs to be work done especially in the manufacturing sector. Last Monday the reading from the Empire State Manufacturing Survey was a disappointment but later in the week the Philadelphia Fed Business Outlook Survey was better than expected. On Monday we will get the Chicago Fed national Activity Index with Durable Goods on Thursday

Of course it was the FOMC minutes last week that helped push the market over the edge as once again the debate picked up as to when the Fed would raise rates.

The Housing Market Index and Existing Home Sale data last week was positive as the homebuilder stocks rallied early in the week before they were also hit at the end of the week. This week we get the S&P Case Shiller HPI on Tuesday as well as New Home Sales that will be followed Thursday by the Pending Home Sales Index.

We will get an additional reading on the consumer with Consumer Confidence on Tuesday followed by the Consumer Sentiment on Friday. On Thursday we will also get the second reading on the 2nd quarter GDP.

Despite the heavy selling also in the Euro zone markets their Purchasing Managers report on Friday did show solid growth.

Interest Rates & Commodities

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Bonds and gold were some of the few winners last week. The 10 Year T-Note yield chart from last week indicated that yields would move lower and bonds would move higher. The uptrend on the weekly yield chart, line b, was broken last week and a break of the 2.00% level will suggest a decline to the 1.649% area, line c. The MACD-His had turned negative a week ago and has dropped further into the sell mode.

Of course crude oil prices were punished again last week which has caused some of the most bearish analysts to lower their price targets to $30 per barrel or lower. There are no signs yet of a bottom but the high level of bearish sentiment suggests that traders should be on the outlook for a short covering rally.

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It was a good week for gold as the futures gained $46 per ounce. The weekly high close doji buy signal last week was a positive sign that did materialize into a price gain. The resistance from late last year and early this year, line a, has now been slightly overcome. There is next resistance now in the $1200-$1215 area and the quarterly pivot resistance. The weekly studies have turned higher but still are well below their key resistance levels (lines b and c) suggesting that a major low may still not be in place.

Market Wrap

There certainly wasn’t any bargain hunting into the close on Friday as the major averages settled on their lows with the futures dropping even further after the close. The 1000 drop in the Dow pushed it down 5.82% for the week, pretty much in line with the 5.77% drop in the S&P 500. The Nasdaq Composite was hit the hardest losing 6.78%.

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As one would expect the market internals were very negative for the week with 2878 stocks declining and just 384 advancing. The weekly chart of the NYSE Composite shows that the next real support is at the October 2014 low of 9868 (line a) which is 3% below Friday’s close. The major 38.2% Fibonacci retracement support from the October 2011 low is at 9415 or 7.6% Lower.

The NYSE Advance/Decline line dropped below its WMA on June 12th warning that the market was in the corrective mode. The A/D line has next support at line b, which was the October low. The NYSE ARMs Index closed at 2.90, a level that may be signaling a panic low. The daily McClellan oscillator closed at -227 which is the lowest level since December 2014.

The NYSE closed below both the weekly and daily starc- bands with the monthly at 9833. The 20 day EMA was tested early last week and now stands at 10,723 but an oversold bounce is unlikely to reach this level.

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The Spyder Trust (SPY) also closed well below its weekly starc- band with the monthly at $193.35 which is just above the weekly uptrend, line a. For September the tentative monthly pivot support is at $188.36 or 4.7% below Friday’s close.

The S&P 500 A/D line dropped below its WMA the week of June 5th, line a. It made new correction lows this week and is still in a clear downtrend as it has been since July. There is nextgood support at the 2014 lows, line a.

The daily A/D line (not shown) has been in a solid downtrend since it formed a slight divergence in May and the failure of the A/D line to overcome this resistance was a sign that the correction was not over. On Friday the daily A/D line plunged well below the July lows.

The weekly OBV has been holding up much better than prices as while it has now dropped below its WMA it is well above the long term support at line d. The daily OBV just tested its declining WMA on Monday before it plunged.

For the Powershares QQQ Trust (QQQ) the next good support is in the $98.90-$100 area with the October 2014 low of $89.49.

The iShares Russell 2000 has already reached my initial downside target in the $114-$116 area. There is next major support for IWM in the $108.50-$110 area.

What to do?

I start writing the week ahead column early each Friday and the heavy degree of selling late in did change my focus. It now seems less likely that the current correction is going to resemble 2012.

A correction like 2011 or possible even 1998 when the Russian Ruble collapsed looks more likely. In 1998 the stock market topped on July 24th and bottomed in early October. We may not see as large a drop as we did in 201 or 1998 but it may last as long. As was the case in 1998 I expect the technical studies to give us ample warning that the market has bottomed.

In my June 30th column “Three Reasons To Stay Patient” I outlined the signs I was looking for to signal that the market’s correction was over.

Three reasons to be patient

Wait for clear signs from the A/D lines that the correction is over

AAII bullish% now at 35.6% needs to drop to the low 20% area

The percentage of S&P 500 stocks above their 50 day MA needs to turn up from the 20-25% level

The A/D line always is the dominant factor and it has been in a solid downtrend since early in the summer. With Friday’s plunge it will take some time before it can break its downtrend and start a new uptrend.

It is likely that the bullish % of individual investors will drop to the low 20% level in this week’s survey but as I have noted before it can bottom ahead of prices and stay at low levels for a number of weeks.

The percentage of S&P 500 stocks above their 50 day MA dropped to 20.36% on Friday while the 5 day MA is at 41.64% and still declining. The MA dropped below the 20 level last October so it can still get more oversold before it turns higher.

For those who are already committed to the stock market it is likely to be a rough month or so as the current decline could last into the fall. The only good news is for those who are not yet in the stock market as there should be an excellent buying opportunity once the stock market bottoms out.

My analysis shows no signs that we have started a bear market or that the economy is starting a new recession. Therefore I do expect a good market rally in the last quarter of 2015. I will continue to be watching the large diversified global ETFs that I discussed in early August.

Some of you may find my past articles beneficial in understanding the current correction.

The Week Ahead: Damn the Torpedoes …. – July 18th, 2015

The Week Ahead: Should You Trust Thus Rally? – July 11th

The Week Ahead: Greece Isn’t The Real Problem – July 4, 2015

If you are interested in my other market services or would like me to speak to your investment group I can be contacted at wentworthresearch@gmail.com.

I will be out of the office next week but will share my market thoughts during the week on both Twitter and StockTwits