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The Week Ahead: Time To Join The Bear Market Camp?

Posted by on Sep 5, 2015

The Week Ahead: Time To Join The Bear Market Camp?

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?

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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.

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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.

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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.

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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 Economy

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.

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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.

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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

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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.

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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.

Market Wrap

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.

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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.

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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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