Today's Market Observation  09.15.2009  Mon  Tue  Wed  Thu  Fri  Barbera Archive

Market Potpourri

by Frank Barbera, CMT | september 15, 2009

The quiet interludes, the ones without the heavy drama of wide swinging market days, these can often be just as nerve wracking as the fast trending markets. To some degree, from an analytical point of view, the one benefit that we find when volatility is high is that normally markets are trending strongly in one direction. At times like that, the trend is always your friend, and experienced traders know to basically use counter trend movements to initiate new positions in the direction of the basic trend.

However, at other times, we find markets where the trend may appear to be less pronounced, or on the verge of some type of more important trend change. These much quieter markets can be nerve wracking as it can be extremely difficult to evaluate when to get in, whether to stay in, or where to get out. In the case of the US stock market, the pace of the robust multi-week, indeed, multi-month advance has slowed more notably in the last few weeks. In this market, we see the indices almost ‘drifting’ higher, but seemingly starting to lack some of the high conviction that was present throughout much of the earlier advance. In my view, this is most likely a hint that the beginning of a distribution process is getting underway, and that the advance is starting to lose some internal technical strength. Yet so far, the drop off in market technicals has been ‘modest’ at worst, mostly showing up in moderately lower values in the markets momentum indicators. This is not uncommon as an advance begins to mature. Yet, while some price momentum gauges are slowly beginning to weaken, other measurements of internal market strength are still holding together. Take the action of the daily Advance-Decline for a moment.

Above: S&P 500 with Cumulative Daily A/D Line – still, making new highs for the move.

In the chart above, we show the day to day action of the Cumulative Advance-Decline Line, in this case, just including the 1500 operating companies in our universe of stocks. As you can see the index is still making new highs, and thus far has NOT been lagging behind the price action in the major stock market averages. The Advance-Decline Line is a running cumulative total of the number of advancing issues each day versus those declining. In the same chart, I plot the 200 day moving average, and the 200 day Bollinger Bands around the A/D Line. Notice that in recent weeks the 200 day average for both the S&P and the A/D Line has turned up, while the A/D Line has surged up and outside the 200 day upper band. That is a sign of strength, and is largely substantiated by the fact that the A/D Line has managed to maintain itself outside (above) the upper band.

Above: At a value last night of +4049.25, the Detrend A/D Oscillator is still very strong.

Perhaps even more importantly we note that the A/D Line is now far, far above the 200 day average. In the chart above, I plot the ‘spread’ between the value of the Daily A/D Line and its own 200 day moving average. This is known as a “detrend oscillator’ and it shows that the A/D Line as of last night as an amazing +4,049 units above the 200 day moving average. As can be seen in the chart above, going back over the last 20 years the reading seen last night is one of three or four prior values in the +4,000 zone.

Looking back, we find that there is a duality to these kinds of values. First off, these values are never seen at final market tops, and at worst can precede a medium term high by a few weeks. They usually occur in the middle, to two third’s waypoint within strong rallies. For a little more enlightenment we can look back at the last set of readings on a close up basis going back to the time period in early 2007. In this chart, the vertical dashed line shows the first value above +4,000. Notice that the S&P 500 (top clip) was still in a strong advance that was still 10 to 15 days before reaching an important peak in early May, and that peak was itself only a preamble to a more material Medium Term peak in early July. Following the early July peak, a much more serious medium term correction followed in August 2007, which was then in turn followed by an exhaustion rally leading to the final top in September 2007.

Above: Close up view of Detrend A/D Oscillator in 2007.

In addition to the 2007 episode, two other episodes in 2003/2004 and 1997 both revealed that with the A/D Detrend at or above +4,000, the market is usually two to three weeks away from a more material short term peak of importance. In other words, the high value is a sign of strength and a message not to be too bearish. At the same time, once a short term peak of importance is seen, the usual pattern then becomes (1) a stiff market correction on the order of 5% to 8%, followed by (2) a final advance that is much more noticeably weak and then (3) a major top leading to a serious medium to longer range down turn.

Above: Close up view of Detrend A/D Oscillator in early 2004 (see dashed vertical line)

Above: Close up view of Detrend A/D Oscillator in July 1997 during secular bull market.

In the current instance I believe that because the current rally is still very likely unfolding against the back drop of a secular bear market (as opposed to 1997 when the secular trend was strong up), that a short term top of importance could be seen for the S&P in the 1075 to 1100 zone somewhere in the next 10 to 15 sessions. That would allow the market to push a bit higher, and then begin to congest up in a small topping pattern. Following the completion of a short-term top, perhaps later this month, we could then see a nasty spill followed by a recovery rally that is of much lower “technical” quality. The implication that we take away would be one of either an October or November peak followed by a resumption of the bear market in 2010. Thus, it may still be a bit too early to sell, and a bit too early to get ‘very nervous’. However, we are at the stage of the advance where ‘stepped up’ daily monitoring is necessary, and if the market does turn down sharply before reaching the 1075 to 1100 target window, that would be a sign of greater than expected weakness and would likely hasten our move for the exits on any ensuing recovery rally.

Another chart I like to watch for clues as to the market internal strength is the Daily Cumulative Ratio of Up to Down Volume. Shown in the graph above, we once again note that by and large, this gauge is still very close to new recovery highs, and is by and large still confirming the recent surge in stock prices. Still more evidence is present on the next chart, which is very short term cousin to the Cumulative Up to Down Volume gauge, in this case, the Short Term Ratio of Up to Down Volume.

Notice that the surge coming off the July lows was strong enough to lift the Up to Down Volume Oscillator very close to the levels seen at the rally inception in March. The fact that the secondary July “kick off” was this strong, and that prices have continued to gain even as the oscillator has come off the highs, all of this still suggests a reasonably robust market climate. In my work I regularly go through a process of scanning multiple market sectors and to that end, the one sector that seems like it may be getting close to an important relative strength breakout is Energy, where we see that large cap energy stocks have been in a declining pattern on the Relative Strength Ratio. This has been true for both large Oil and Gas and the Natural Gas stocks. However, as we put this editorial together on Tuesday morning, many of these issues are strengthening with the likely outcome being that Oil and Gas issues are now likely in the act of turning materially up. In my view, the recent downside break out in the US Dollar should be market supportive for Energy, and if Energy can manage a more robust advance, that could help extend the overall stock market rally for several more weeks. In the past, energy stocks have been notorious as one of the last sectors to peak out a market advance, with Energy often providing ‘rear guard’ action for the broad market. Right now, it looks like a repeat of past cycles may be on track.

 

Above: the Relative Strength Ratios of Large Cap Energy (upper) vs. S&P and Natural Gas (Bold-lower) versus S&P. Both appear to be starting a break out move with today’s action and that is a potential positive for the stock market indices as these sectors have a material weighting.

Yet another sector that is slowly and just perceptively starting to show signs of life is, believe it or not, the Agricultural commodities. I also watch these as a potential ‘portfolio diversifier' as the correlation of Agriculture to the financial markets is very, very low. In my work, I plot an unweighted index of the Grains, including Wheat, Soybeans and Corn. As can be seen in the next chart, the index is attempting a potential double bottom with the major lows seen in mid-October and December 2008. On the medium term RSI, we now see definitive positive divergences taking shape which suggests that if prices are able to begin a steady advance, a more substantial bottom may have just been completed. Within the grains, almost all of the leadership will need to come from Soybeans and Corn as the outlook for Wheat remains fundamentally negative with large supplies.

Above: GST Unweighted Grain Index with Medium Term RSI

Above: GST Unweighted Index with potential positive divergence on DBA, as Soybeans refuse to make new lows.

Above: The three grains, Soybeans (potential leadership), Corn (middle) and Wheat – the laggard (bottom)

In the case of nearby Soybeans, major support continues in the mid to low $900 zone, while for Corn, the $290 which was seen in early December 2008 is critical support. For nearby Wheat prices have recently broken down and for the grain complex as a whole, it would be encouraging if Wheat prices could quickly scamper back above the recently violated $440 level. If Wheat can confirm strength in Beans and Corn with a sharp upside reversal, that would probably suggest a more bullish outlook in the months ahead for the entire grain complex.

Finally, I end with a strong note of caution on one final sector, that being the sector of High Yield “Junk’ Bonds. In this case, my index of Junk Bonds has experienced an enormous advance, the likes of which have never been seen before especially in such a short period of time. In passing, we note that medium term Daily RSI values are now at the highest, most overbought values seen since early 2007, when the index last recorded a major peak. While these bonds throw off an incredible yield, they are relatively a lot more over-extended than the stock market as a whole, and this is one area I would be watching very closely for signs of a substantial downside correction.

Above: GST Junk Bond Index with medium term RSI, -- massively overbought.

That’s all for now,

Frank Barbera
The Gold Stock Technician

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Frank Barbera
The Gold Stock Technician
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