A common problem for both investors and traders is that they buy too high and sell too low. Everyone at some time has picked a stock or ETF to buy only to see the market take off without them. Often times the market will move up for several days in a row increasing the frustration and the urge to buy. Finally some will throw caution to the wind and buy only to see the market reverse back to lower levels which may stop them out..
The same pitfall can impact investors who hold on to a stock in their portfolio as it starts to fall. Selling out the position can mean that the investor has to “face up” to their mistake. This is hard for anyone to do but finally when they sell out their position it will often rally 1-2% or more just after you get out.
Managing risk is a key factor in profitable investing or trading. If you can avoid selling near a short term low or buying near a short term high it will definitely improve your overall results.
Starc bands were developed in the mid-1980s by the late Manning Stoller, with whom I had the pleasure of teaching technical analysis in many cities around the world. Starc stands for the “Stoller Average Range Channel,” and by far, these are my favorite banding or channel techniques. It should be noted that they are interpreted much differently than Bollinger Bands.
The same formula is used on all markets and for any time frame and is as follows:
Starc+ = 6-period moving average + (2 x 15-period Average True Range) (ATR)
Starc- = 6-period moving average – (2 x 15-period Average True Range) (ATR)
The Average True Range (ATR) was developed by Welles Wilder and a fourteen period ATR is used for starc bands.
The beauty of the starc bands is that unlike most indicators or methods, they can tell you when it is a high- or low-risk time to buy or sell. Using two times the ATR, Stoller estimated that 90% of the price activity should stay within the bands.
As for interpretation, if prices are near the Starc+ bands, it is a high-risk time to buy and a low-risk time to sell. Conversely, when prices are near the starc- band, it is a low-risk time to buy and a high-risk time to sell if the other technical indicators agree with the starc band warnings..
Many of you may remember the stock market action on Wednesday October 15th when stocks and bonds were both plunging in early trading. At the time several well know media analysts had just proclaimed the start of a new bear market.
The PowwerShares QQQ Trust (QQQ) had closed on the lows the previous Friday at $93.66. The lower starc band (starc-) for the following week was not much lower at $93.08. The low early Wednesday at $89.42 was 4.5% below the weekly band.
The daily chart of QQQ on the right shows that it had also closed near the daily starc- band (see arrow). The lows on both Wednesday and Thursday exceeded or tested the starc- band. Though there were no clear signs of a bottom the fact that the QQQ was trading below both the weekly and daily starc- bands confirmed that it was a high risk time to sell or to establish new short positions.
The rally from these lows was relentless and on November 28th the QQQ closed at $104.88 (point 2) which was just above the daily starc+ band at $104.80. Over the next twelve days the QQQ dropped 5.6% to close below the daily starc- band.
The daily starc bands can also give you quite a bit of insight even in choppy markets. The PowerShares QQQ Trust (QQQ) closed at a new high on the first day of trading in March 2015 before declining for the next eight days.
This correction took prices to the starc- band for three consecutive days, point 1, before the QQQ turned higher. After three strong days on the upside some may have been tempted to buy but the rally topped out just two days later (point 2).
Over the next four days the QQQ lost over 3% to close on the daily starc- band. The lows held on a retest in early April before the QQQ started a three week rally. On both April 24th and 25th the QQQ reached the starc+ band (point 4) and even though prices had surpassed the March highs the starc band analysis warned it was not the time to buy.
In the next seven days of trading the QQQ dropped 3.8% and came close to the starc- band before developing a range that lasted until late June when the starc- band was tested for two consecutive days (point 5). The QQQ moved sideways for three days, a normal reaction after the starc- band is tested, before dropping to marginal new lows.
The rally from the lows was impressive as the Nasdaq 100 and the Nasdaq Composite both made new highs on July 20th as the starc+ band was tested (point 6). The new highs in both averages received considerable attention in the media that could have tempted some to buy.
The Nasdaq 100 Advance/Decline line had peaked in May and had formed lower highs in June. As I pointed out on July 21st (“Narrow Advance Warrants Caution” ) the A/D line just reached its downtrend which was key resistance. This was a sign of weakness as it indicated that just a few stocks were pushing the Nasdaq 100 to new highs.
Often when one sees an extreme price the tendency is to take action which often results in one getting in or out at the worst price. The panic open on August 24th briefly pushed many ETFs to absurdly low prices in the first few minutes of trading. There were several stories in the press about financial advisors who sold on the opening as the wide swings were apparently the result of the inability to price individual components of many ETFs.
On August 24th the Spyder Trust (SPY) dropped below the monthly, weekly and daily starc- band as it hit a low of $181.46 which was 5% below the monthly starc- band at $191.00. This was the most extreme reading since 2011. As of last week’s high the SPY had rallied over 11% from the August 24th low. For the week of September 20th the weekly starc- band stands at $188.72 with the daily at $192.46.
The formula for the starc bands is quite straightforward, it is not difficult to add it to most charting packages. In some cases Keltner channels can be modified to produce starc bands. First the moving average will need to be changed to six with two ATR added to or subtracted from this moving average.
I use these bands in both my investing and trading as I even run it on the mutual funds in my 401(k). I also use the bands to help determine a limit price to enter or exit a position. As with any good indicator, I suggest that you work with it first, study it on several markets, and convince yourself that it can help you before using it on a real-time basis.
In future articles I will show how a short term momentum indicator can be used in conjunction with the starc bands.
The Fed’s decision to stand pat on rates disappointed investors as those who have been finding fault with their strategy for many years had something more to complain about while others were understandably concerned over their cautious view of the economy.
The market weakness on Friday is likely a sign that the market’s rebound from the August 24th lows is over. I am still not expecting a major decline to significant new lows but it is possible. In my experience when the WSJ recognizes the flag or pennant formations it is less likely to be resolved in a classic technical manner.
I do think that the investors should be using the current market decline to start making solid plans for what they will do with their portfolio in the coming months. This is true for those who already have a stock portfolio as well as those who are in cash on the sidelines. The failure of investors to have a concrete plan for their portfolio often means that they end up reacting emotionally which adversely impacts their portfolio.
Let’s look at the likely scenarios over the month or so and why it will be important to take a proactive approach to managing your portfolio.
The monthly close only chart of the S&P 500 goes back to 1989 and shows the powerful rally from the recession low in 1990 to the 2000 high. After dropping below the 20 month EMA in 2000 the S&P rallied back to its WMA in early 2001 before declining more sharply.
By the middle of 2003 the S&P was back above its WMA and the uptrend from the lows, line b, was not broken until late 2007. Subsequently the 20 month EMA was also violated. From high to low the S&P 500 lost 20% during the initial decline. In the spring of 2008 the S&P 500 rallied 14% as it moved back to its EMA before the selling once again accelerated.
The S&P 500 first closed back above its monthly EMA in November 2009 though it subsequently dropped back below it during both the 2010 and 2011 market corrections. Since October 2011 the S&P 500 has stayed solidly above its 20 month EMA which is being tested this month.
The break through the long term resistance, line a, In April 2013 I believe was significant. Since the early 1980’s I have found that moves above long term resistance or below long term support are quite reliable. The width of the trading range, lines a and d, still has upside targets in the 2480-2500 area.
The long term charts also illustrate that major tops take time to form. Therefore a close below the 20 month EMA (currently at 1967) in September would make the October close even more important. Two consecutive monthly closes below the 20 month EMA would be more negative and would suggest that a major top may be forming.
From the July high to the August low the Spyder Trust (SPY) dropped 14%. If these lows are tested or broken over the next few weeks the market is likely to then form a bottom. The following rally will be either a resumption of the major uptrend or an oversold bounce back major resistance as part of the topping process. In 2008 the ten week rebound from the March lows retraced 61.8% of the decline from the October 2007 high. In May 2008 the rally’s completion was clear on the charts.
For those that are already in the stock market or those that are now considering getting into the stock market it will be important to develop your plan before the next correction low.
For those who are not currently in the stock market and do not have the time or interest to trade a traditional 60% stock and 40% bond portfolio could be considered once the current decline is over. This approach is followed by the institutional Vanguard Balanced Index Fund (VBAIZ) which has total assets of $25.5 billion. Even though it may not be available to the average investor I think its performance since the 2002 lows does illustrate what investors who follow this portfolio allocation can expect.
During the 2002–2007 bull market VBAIX gained over 50% before it dropped 13% from the October 2007 high to the March 2008 low. VBAIX rebounded 5% from the lows and moved just above the 20 month EMA before again turning lower.
On the chart I have added the performance of VBAIX from 2010 through 2014. Also according to Morningstar it was down 22.1% in 2008 and up 20.2% in 2009. For comparison the Spyder Trust (SPY) was down 36.8% in 2008 but up 26.4% in 2009.
On the chart you will note that VBAIZ had a 11.5% drop in 2010 and a 17% drop in 2011. Using the recent low the decline from the July high has been 9.5% so the current pullback is in line with the prior corrections in this bull market. The EMA of the performance will take several more months before it could turn lower.
New buying done near the correction lows will need to be watched closely for any signs that the rally is failing. For those who are already invested in stocks the rally will be an opportunity to further adjust your portfolio and determine what percentage you want in stocks should the rally fail.
In the coming weeks start to identify which of your holdings are lagging the market as they will be more vulnerable during a market decline and rally less when the market turns higher.
The Euro zone markets were hit hard Friday with the FTSE down 2.6% and the DAX index was down over 3% on the day. The failure of the Fed to raise rates may push the ECB to add more stimulation to their markets and such a move could help stabilize their markets at lower levels.
I continue to think that the DAX may bottom out before the S&P 500 as it topped out before the U.S. earlier this year. The monthly chart shows that the uptrend, line b, from the 2011 and 2012 lows was tested in August. The recent low was well above the October 2014 low of 8354.
The monthly chart also reveals that the upper parallel trading channel (line a) from the 2009-2011 lows, line c, was tested earlier this year. This is reason for concern as often such resistance levels can correspond to a major high. The monthly EMA may flatten out his month and if the August lows do hold there is retracement resistance at 10,877.
Tuesday’s Retail Sales was a bit lower than expected but the sharp upward revision in July’s data is still a clear positive for the consumer. Of course the fall is typically a seasonally strong period for the consumer stocks.
The chart shows a clear uptrend, line b, that goes back to the 2009-2010 lows. It shows no signs yet of topping out. In 2007 the support at line a, was broken late in the year as Retail Sales dropped sharply in the last recession.
The Empire State Manufacturing Survey came in very weak for the second month in a row as it was the weakest reading since April 2009. Industrial Production was also weak and the drop in the Philadelphia Fed Business Outlook Survey suggested to Econoday ” There may very well be something wrong with the manufacturing sector, at least in the Northeast”.
The Housing Market Index released last Wednesday continued to show optimism from the builders. Housing Starts were a bit lower in August but permits were up which should be a plus in the months ahead.
The Leading Economic Indicators (LEI) were up 0.1% in August which was below expectations. It suggests that we may not see much stronger growth going into the end of the year but it does not indicate we are close to a recession.
On Monday we get Existing Home Sales followed on Tuesday by the Richmond Fed Manufacturing Survey. The flash PMI Manufacturing Index is out on Wednesday followed by Durable Goods and New Home Sales on Thursday. The final reading on 2nd quarter GDP comes out on Friday along with the month end reading on Consumer Sentiment from the University of Michigan.
Interest Sates & Commodities
The yield on the 10 Year T-Note closed at 2.303% on Wednesday but finished the week at 2.130% as the short term uptrend was broken. The longer term uptrend, line a, was broken in late August.
The close this week turns the focus back on lower yields with the key support in the 2% area. Those looking to refinance may have one more drop in yields in the next month or so. The weekly MACDs has been negative since August 21st and the daily MACD looks ready to roll over this week.
The Comex Gold futures were up over $21 on Friday and gained $34.8 for the week. The weekly chart shows a potential short term bottom formation, line c. The near term downtrend, line b, is now in the $110.65 area with the long term downtrend just below $120.
The weekly on-balance-volume (OBV) broke below important support, line d, in July which was a sign of weakness. The OBV still looks negative as it is well below its declining WMA. The daily OBV is above its WMA as volume increased over the past few days when prices moved higher.
As of last Tuesday’s close the technical studies suggested that crude oil and the SPDR S&P 500 Oil & Gas ETF (XOP) were bottoming. All they needed was a higher daily close to complete their bottom formations. Crude was higher in early trading Wednesday and then accelerated to the upside on a bullish inventory report. The market gave up its gains Friday as crude closed 4.7% lower to settle just a bit higher for the week. Technically crude oil still appears to be bottoming as this week’s action may be important.
The sharp decline Friday on the third heaviest volume of the year erased all of the market gains early in the week. The volume was exceptionally high because of quadruple witching as option and futures expired.
The Dow Industrials were down 0.30% while the S&P 500 lost just 0.15% and the Russell 2000 was up 0.48% for the week. The star performer was the Dow Utilities which gained 2.83% for the week.
The weekly outlook, basis the NYSE Composite, is still negative for the stock market as last week’s rally appears to have failed at 10,362. The declining 20 week EMA at 10,600 now represents more important resistance. On a drop below 9800 we could see a test of the August lows in the 9500 area.
The weekly NYSE A/D line dropped below its WMA on June 5th (line 1) which warned of the current market decline. The A/D ratios were positive last week so the A/D line has turned up but it is well below its WMA.
It would take a couple of weeks of strong A/D numbers to move the A/D line back above its WMA. There is next major support for the A/D line at line a. The weekly OBV is below its WMA but still above the important support at line b.
The downside reversal on Thursday (see arrow) set the tone for Friday’s session as did the overseas markets. The close was just below the 20 day EMA with next support in the $193-$193.50 area. A break of this level will make a drop to the $190 area more likely.
The S&P 500 A/D line reversed sharply at the end of the week and closed on its rising WMA. A day of positive A/D numbers Monday is needed to avoid further deterioration. The daily OBV dropped to new lows for the month on Friday which is a sign of weakness.
The weekly and daily relative performance analysis indicates that both the PowerShares QQQ Trust (QQQ) and the iShares Russell 2000 (IWM) are acting stronger than the S&P 500. Once the current market decline is over these are the ETFs that are likely to lead the market higher. Therefore they will be favored for new long positions.
What to do?
The market is likely to stay nervous this week as it digests the Fed’s new weaker than expected appraisal of the economy. The sentiment picture remains mixed as the individual investor according to AAII does not reflect an extreme in sentiment. The bullish% is at 33.1% down slightly last week while the bearish% dropped 5.4% to 29.1%. The put/call data does suggest that bearish sentiment is quite high as the levels are consistent with a market bottom.
It is likely to be a tough period for investors but I think that it will present a good buying opportunity once the market internals turn the corner. For those not in the market this will be a chance to buy while those already in the market should use the next few weeks to prune the market laggards from their portfolio.
The high degree of volatility means that traders will have to stay nimble and take profits when they occur.
As we get closer to the FOMC announcement Thursday stock market investors are starting to look at which sectors and stocks look the best and which look the worst. The market was led higher Tuesday by the Dow Transports which were up 1.85%.
The daily relative performance analysis of the iShares Dow Jones Transportation (ETF) versus the Sypder Trust(SPY) indicated it had become a market leader on September 2nd. With last Friday’s close the weekly RS analysis for IYT has also completed its bottom formation. Typically when a stock or ETF becomes a market leader there will be a pullback in the following weeks which will present an additional good risk/reward entry point.
The A/D ratios were better than 2-1 positive and while the A/D line ratios have turned higher they have still not signaled that the market’s correction is over. The failure to overcome these levels over the past few months has kept us from aggressive buying
As part of the bottoming process a stock or sector will pullback after the initial rally and then traders will look for a trigger or spark to suggest that the rally is ready to resume. Crude oil is up in early trading and there is one energy sector ETF that I am watching for a new buy signal.
The daily chart of November crude oil shows that it hit a high of $49.33 at the end of August but has been consolidating for the past nine days.
- Crude made a secondary correction low at $43.36 last week and it is trading $ higher early Wednesday.
- The short term downtrend, line a, is now in the $46.20-$46.40 area.
- A close above this level should signal a move to the $49-$50 area.
- The monthly projected pivot resistance stands at $53.10
- The volume increased Tuesday with the slightly higher close.
- The daily on-balance-volume (OBV) is poised just below its WMA while the weekly is still negative.
- The Herrick Payoff Index (HPI) as I noted several weeks ago has formed a longer term bullish divergence, line c.
- The HPI is holding above the zero line so money flow is still positive and a move back above its WMA will generate a bullish trigger.
The SPDR S&P Oil & Gas (XOP) has pulled back 8.6% from the late August high of $38.59
- The 20 day EMA is at $36.42 with the monthly pivot at $37.26.
- The daily starc+ band is at $39.14 with monthly projected pivot resistance at $41.73.
- The relative performance did not make a new low in the middle of August.
- The RS line is below its WMA and needs to overcome the resistance at line d, to signal that it is a market leader.
- The OBV flipped back above its WMA on Tuesday which is a positive sign.
- A move in the OBV above the resistance at line d would be a stronger bullish sign.
- There is initial support at $34.50 and then in the $33.80 area.
What to do? A positive close today will be a short term positive for both crude and XOP. The strength of a rally over the next few sessions will be important in determining whether they have made a short term low or more.
For specific entry and exit signals you can contact us at wentworthresearch@ gmail.com
My market updates can also be found on both Twitter and StockTwits.
The narrowing ranges in the stock market over the past two weeks and the fact that it did not collapse last week appears to have soothed some investors. Surprisingly the rough market action over the past month has apparently has not caused investors to panic. Morningstar reported last week that outflows from US stock mutual funds and ETFs in August was only $4.9 billion as compared in $9.6 billion in July.
This relatively low level of outflows (it was $25.9 billion in April) and 2.3% uptick in bullishness by individual investors in the past AAII survey is not what one would typically see if the market was close to an important low. According to AAII the bullish and bearish percentages as of Thursday’s survey are about equal at 34.6% and 35% respectively.
These readings can be interpreted as a sign that the individual investors are becoming more astute or it is a sign of complacency that will lead to a further market decline. How will the current market action be viewed at the end of 2015?
On the weekly chart of the S&P 500 I have added the economic headlines that coincided with some of the important stock market lows since 2010. They illustrate some of the economic concerns as well as the fears of investors that accompanied some of these market corrections.
Prior to each of these market lows there was generally an increasing level of bearish commentary. In May 2010 an Economist article highlighted some of the market’s concerns as they said ” Fears are growing that the global recovery will falter as Europe’s debt crisis spreads, China’s property bubble bursts and America’s stimulus-fuelled rebound peters out. ”
These concerns still sound quite familiar but then the Economist correctly concluded that the fears were exaggerated. In June 2010 Paul Krugman warned that policy makers concern over inflation could cause “The Third Depression” as he felt that deflation was the real threat.
By August this was a more common view as noted in in the WSJ “Big Investors Fear Deflation”. This coincided with multiple low readings (20-22%) in the AAII bullish individual investor sentiment. The stock market decline ended in early September as the NYSE A/D line completed its bottom formation.
These global fears surfaced again in 2011 as the correction lasted from late July until early October. This correction in my view (The Week Ahead: A Replay of 2011 or 2012?) had some similarities to the current market decline. Fears of a new recession dominated the press after the debt ceiling crisis and the lowered rating of US debt.
The decline in August 2015 was the worst since the May 2012 drop of 6.2% as investors then scrambled to buy bonds as yields dropped below 1.5%. Stocks bottomed in early June of 2012 as both the NYSE A/D line and McClellan oscillator formed bullish divergences.
On the chart I have also annotated the correction in late 2012 as well as those in 2013 and then in early 2014 when the GDP turned briefly negative. On October 15th of 2014 the Guardian article “Fears of global slowdown spark fall on European and US stockmarkets” corresponded with the market’s low.
Last Friday the German finance warned that “the global economy faces a financial bubble from central banks pumping cash into economies” and of course this comes as the market waits for the FOMC meeting next week.
So at the end of 2015 analysts may conclude that this market decline was caused by fears of a September rate hike that ultimately did or did not occur. If the next multiple week market rally is not impressive analysts may point to the current complacency as a warning for the market going into 2016.
The flag formation on the chart of the NYSE Composite is still intact as the support, line b, was tested several times last week. The fact that this formation is now getting so much media attention makes it less reliable and favors more choppy action. A sharply lower close early in the week and a break of support may not see any follow through to the downside.
The several levels of resistance in the NYSE A/D line are still intact with the major downtrend, line c, representing the bearish divergence from the May highs. The first sign that the market had improved would be a break of the short term downtrend (dashed line) . A move above the further resistance at line d, would be much more encouraging.
The downtrend in the OBV has been broken as the WMA is now trying to flatten out. The monthly pivot and the declining 20 day EMA are now at 10,201 and represent the first level of resistance. There is more important resistance now at 10,350-500 with chart resistance at 10,750 (line a).
There was little in the way of economic data last week as the Producer Price Index came in unchanged which was weaker than expected. More importantly Friday’s mid-month reading on Consumer Sentiment from the University of Michigan came in at a disappointing 85.7 which was down from July’s 91.
This preliminary report looks pretty negative on the chart (courtesy of dhort.com) but it is the final monthly reading on September 25th that is important. The downtrend from the 2000 highs, line a, was broken in early in 2014 and this positive signal is still intact.
We will get another reading on the consumer Tuesday with the Retail Sales report but the focus will be on the FOMC meeting that starts Wednesday and concludes Thursday afternoon with the Fed Chair’s press conference.
There is plenty of data on manufacturing this week with the Empire State Manufacturing Survey, Industrial Production and Business Inventories on Tuesday. This will be followed by the Philadelphia Fed Business Outlook Survey Thursday and the all important Leading Economic Indicators (see last week) on Friday.
On the housing front we have the Housing Market Index on Wednesday followed by the Housing Starts on Thursday.
Interest Rates & Commodities
The yield on the 10 Year T-Note rose slightly last week but there was no change in either the weekly or daily technical studies. The weekly MACD is still negative while the daily is negative as yields have just rallied back to the underside of the daily uptrend.
The junk bond ETFs have had a tough year as the plunging bonds of some energy companies have depressed the high yield market. The SPDR Barclays High yield Bond ETF (JNK) is down 9.1% from its 52 week high. Since the August 24th panic low of $35.83 JNK has rallied sharply but the rebound looks like just a pause in the downtrend.
The downtrend, line a, is at $37.25 with the daily starc- band at $37.48. There is further resistance in the $38 area. The OBV broke support, line c, on May 12th (line 1) well ahead of prices. It has been in a downtrend (line b) since then and shows no signs yet of a bottom.
The SPDR Gold Trust (GLD) closed the week lower in line with the negative technical readings last week and the weekly OBV made a convincing new low with prices. This confirms that the rebound from the July lows was just a bull trap.
Crude oil was also lower as it was down $1.29 on Friday. The market was hit with more bearish fundamental news. Goldman also commented that the risk of crude oil falling to $20 was rising. This is in contrast to the technical outlook which indicates prices are stabilizing, A sharply higher weekly close could complete a bottom.
It was a good week for stocks with the Dow Industrials and S&P 500 up 2% but both lagged the 3.3% gain in the Dow Transports. The Nasdaq Composite also was up close to 3% but the market internals were not as strong as prices with 1808 advancing and 1409 declining.
The daily chart of the Spyder Trust (SPY) has shown little change over the past week as prices have been bumping into the 20 day EMA but it has failed to close above the monthly pivot at $197.08. There is more important resistance at $200 with major in the $204 area, line a. There is initial chart support in the $194 area with further at $190.50-$191.50.
The S&P 500 A/D line is in a short term uptrend as it closed the week just above its WMA which is trying to flatten out. The A/D line has initial resistance at the July lows with major still at the downtrend, line b. The OBV has also moved above its WMA but has strong resistance at line c.
The daily chart of the iShares Russell 2000 (IWM) shows a better defined continuation pattern and a close below $111.60 would signal a drop back towards the August lows. The daily starc- band is at $109.15. Once above last week’s high at $116.42 the next resistance is at $117.50 (line a). The daily downtrend, line a, is in the $121.50 area.
The small caps were much weaker than the S&P from late June as the downtrend in the relative performance, line b, indicates. The break of this downtrend on August 21st suggested that the IWM was starting to outperform the S&P 500. The uptrend in the RS, line c, suggests IWM is becoming a market leader. The weekly RS analysis is also now trying to bottom.
The daily Russell 2000 A/D line (not shown) is close to breaking its short term downtrend. The daily OBV has turned up but is still slightly below its WMA.
What to do?
It has been my view since early July that the stock market was vulnerable and a high risk buy. I continue to think that it is too early to be an aggressive buyer as bottom fishers are likely to get burned even though the risk was diminished. As I discussed last week (Time To Join The Bear Market Camp?) I do not see signs that we have begun a new bear market.
I would caution traders not to fall for some of the short term positive signals from momentum studies that some analysts are banking on. Having used the MACD and RSI for over 33 years these short term signals only result in short term rallies not sustainable market bottoms.
There are a number of stocks and industry groups that are emerging as new market leaders. Once there are clear signs that the market has bottomed they are likely to continue to outperform the S&P 500.
During the week you can follow my daily stock market analysis via Twitter and StockTwits,
If you are interested in my other market services or would like me to speak to your investment group I can be contacted at firstname.lastname@example.org.
The stock global markets were punished again last week as most traders and investors couldn’t wait for the long weekend. Several analysts last week proclaimed that we are now in a bear market. One of the new bear market forecasts came from a regular TV analyst who last proclaimed a bear market near the October 2014 lows. That of course does not mean that he will be wrong again this time.
The transition from a bull to a bear market is a gradual process which historically takes time. There are generally plenty of signs from the stock market as well as the economy before the major trend changes. There is a good correlation between bear markets and recessions as stocks top out before the economy enters a recession. So should you join the bear market camp?
One of my favorite economic indicators is the Conference Board’s Leading Economic indicator (LEI) which is a composite reading of ten components. As the chart indicates the LEI topped out in 2006 well ahead of the recession’s start in early 2008.
An early warning of the impending bear market was the stock market’s six week drop of 12% in the summer of 2007. The panic selloff in the middle of August 2007 rattled many investors. This set the stage for a rebound into early October when the stock market made its final high.
This new high was accompanied by the formation of a longer term divergence in the NYSE A/D line. This combined with the well established downtrend in the LEI shifted the balance of evidence in favor of a bear market and a recession. Stocsk declined sharply into early 2008 as the bearish sentiment reached a very high level. This set the stage for a classic 16% bear market rally that allowed investors to reduce their equity exposure.
The LEI did decline slightly in July 2015 after a sharp rise in June. The analysis from Doug Short has led him to conclude that “the LEI has historically dropped below its six-month moving average anywhere between 2 to 15 months before a recession. The latest reading of this smoothed rate-of-change suggests no near-term recession risk.”
In over 35 years of using technical analysis I have developed a methodical and objective approach to analyzing the stock market. This allows me to identify benchmarks that tell me when things are changing. These benchmarks have kept me in the correction camp this summer when the Nasdaq 100 was making a new high in July (Narrow Advance Warrants Caution)
In my June 12th Week Ahead column I pointed out that “The week of May 15th the A/D line did not make a new high (see arrow) and then on June 5th it dropped below its WMA and the support at line c. This may be warning of a more significant correction ”
As the summer progressed the deterioration in the market internals became more pronounced and this set the stage for the recent plunge in stock prices. Let’s look at a current chart.
The weekly chart of the NYSE Composite shows that it has already violated the October 2014 lows as it hit 9509 on August 24th. The 38.2% Fibonacci retracement support level from the 2011 low is at 9415 with the 50% support at 8850. This is over 10% below current levels.
The NYSE A/D line violated its WMA after forming a three week negative divergence. The A/D has been holding up better than prices as it is still well above the October 2014 low, line a. If this support is broken it would generate a stronger sell signal. The A/D line is still well below its declining WMA. By the end of the 2011 correction in October the A/D line was closer to its WMA and moved back above it just one week after the low.
The NYSE is now 8% below its 20 week EMA but in October 2014 it was just 4% below its EMA. This along with the fact that prices dropped below both the weekly and monthly starc- bands confirms that the market is now clearly oversold. The Arms Index hit 4.95 last Tuesday which is a level characteristic of a panic low.
Since 2012 the German Dax Index has been leading the S&P 500 both higher and lower. In 2015 it topped out in April well ahead of the US market. The drop two weeks ago took the Dax well below its weekly starc- band and the uptrend ( line b) has been tested. There is even longer term support now in the 8500 area, line a. The MACD and MACD-His dropped more sharply last week and both are still in the sell mode as after turning negative in the middle of May.
The latest survey from AAII reveals that investors have not turned more bearish as 32.4% are still bullish. This is virtually unchanged from the week before and 31.7% are bearish which is down 6.6% in the past week. This week’s data should be quite interesting as I would like to see a much lower bullish % reading before the correction could be complete. (Three Reasons To Stay Patient)
The monthly jobs report missed on the number of new jobs but did reveal some positive as the unemployment rate dropped to 5.1%. The upward revision of the prior two months was a plus as were the increase in hourly wages. The report did stimulate a new round of debates on when the Fed would raise rates and the threat of higher scared investors.
The other data last week, especially on the manufacturing sector, was not as strong as one would like. The solid number from the Chicago PMI was in contrast to the very weak Dallas Fed Manufacturing Survey as the region has been hit hard by plunging crude oil prices.
Nationwide the PMI as well as the ISM Manufacturing index both recorded the lowest readings since May 2013 but are still in the slow growth mode. The ISM is still in a downtrend, line a, and it needs a move above the May high to break the downtrend.
Construction Spending was up last week but Factory Orders were down. The data on the service sector last week was better with the ISM Non-Manufacturing Survey holding on to recent gains as it broke through resistance in July, line a.
There is a light economic calendar this week with the markets closed on Monday. On Thursday we get jobless claims along with Import and Export Prices. On Friday we get the Producer Price Index (PPI) as well as the mid-month reading on Consumer Sentiment from the University of Michigan.
Interest Rates & Commodities
The yield on the 10 Year T-Note was a bit lower last week but held up better than expected in light of the weakness in the global stock markets. The 10 Year is usually the go to safe haven in times of market turmoil.
The break of the uptrend, line b, still favors lower yields and we may just see a sharper decline in yields in the coming weeks. Yields bounced back to the former uptrend two weeks ago before turning lower. A drop below 2.00% is needed to get the market’s attention. The MACD has been negative for the past month which is consistent with lower yields.
The SPDR Gold Trust (GLD) recently tested the downtrend from the highs early in the year (line a) before turning lower. This suggests that the rebound from the July lows may be over. A drop below the support at $104.90 should increase the selling pressure with monthly pivot support at $99.90. Volume increased as the rally stalled with the weekly OBV now close to breaking key support at line c.
Crude oil prices closed the week higher but it was a volatile week. The weekly doji indicates indecision but the daily volume and open interest analysis has improved suggesting that a bottom may now be forming. The oil stocks are clearly starting to outperform the S&P 500.
The Dow Utilities continued their recent slide last week as it lost 5.3% which is more than its current yield of 4%. Most of the other major averages like the Dow Industrials, S&P 500 and Nasdaq were down 3% or more for the week. The small cap Russell 2000 was down just 2.3% while the Dow Transports held up even better losing just 1.5%.
The ugly start for what is historically a poor month for the stock market will have many re-evaluating their equity holdings after the holiday as investors prepare for the last quarter of the year. All the sectors were lower with consumer services and goods holding up the best.
Barron’s cover article this week reviews the generally bullish outlook of Wall Street Strategists which in my view is not a positive for the market as both the weekly and daily technical studies are still negative. After such a severe market decline I would like to see more “gloom and doom” before the market can bottom.
The daily chart of the Spyder Trust (SPY) like many of the market averages shows short term flag or continuation patterns. The drop on Friday came close to completing these patterns so it will not take much more selling early this week to signal another push to the downside. There is next support at $190 and at daily starc- band which is at $188.76.
For the SPY a strong close above the $198 level is needed to signal a rally back to the $200-$202 area which would squeeze the shorts. The sharply declining 20 day EMA indicates it will take time before it could flatten out and turn higher.
The S&P 500 A/D line rallied up to its declining WMA last week before turning lower. As I have noted previously the break of support at line c was a sign of weakness. The A/D line still needs a move above the downtrend, line b, to signal that SPY has bottomed. The daily OBV also still looks weak with key resistance now at line d.
The weekly chart of the Powershares QQQ Trust (QQQ) shows that the long term uptrend, line b, was broken on the early sharp drop on August 24th. The QQQ closed the week above this support which is now at $96.60. The early 2014 high at $90, line a, is now major support.
The weekly Nasdaq 100 A/D line dropped below its WMA on June 5th and is still well below its declining WMA. The A/D line has next major support at line c, which corresponds to the October 2014 low. The weekly OBV has been in a downtrend, line d, since early in the year and closed back below its WMA last week.
The QQQ has initial resistance now at $105.74 and the declining 20 day EMA. There is more important resistance at $107.43 and the quarterly pivot.
My current analysis indicates that it is too early to conclude that we have entered a new bear market. The economy continues to look positive and there are signs that the consumer’s positive outlook will trigger good spending in the months ahead. By the end of the year we need to see better data on manufacturing which is needed to keep the economy in a positive trend.
The stock market will need at least 2-3 weeks of rallies and declines before it could bottom out. The strength of the rally once a bottom is in place will clarify the intermediate term outlook for the stock market. If the market was able to make new highs this fall it could cause the formation of more serious bearish divergences.
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