We continue to see a broad variety of technical evidence accumulating to suggest that the stock market has either already seen a major market low or is very close to an important market bottom. In either case, downside risk levels going forward for the stock market appear to be rather minimal with the weight of the technical evidence now moving strongly into the Bullish camp.

S & P 500 Index

While many advisory services are already proclaiming a “new bear market” in stocks to this point in time, from our point of view, there is not much technical evidence to go on. When looking at the chart of the S&P 500, it is still quite apparent that the S&P 500 remains in a rising parallel channel. Over the course of the last few weeks, it has simply moved down across the pre-existing range. On a daily trend basis, the longer-term 200-day moving average is still in a rising configuration as are a number of important weekly and monthly moving averages.

CBOE Options A/D Ratio

In addition, by reviewing the recent action of the CBOE Weekly Options A/D Ratio, we see that the behavior of the broad market has pulled back to the vicinity of its rising 52-week (or one-year) moving average. This action still spells uptrend in our book as prices are pulling back to rising longer range support. For those who are new to the CBOE Options A/D Ratio, this gauge illustrates the behavior of the broad market by depicting the ratio of advancing versus declining options each week. By focusing on “optionable” stocks, the ratio cuts down on some of the noise present on the NYSE and other A/D lines that are affected by Bond Funds, Country Funds and Preferred Stocks. Note also that the 9-week RSI for the CBOE Options A/D Ratio is now fully oversold in the same configuration seen at the August 13, 2004 major market low. Within the context of an ongoing Bull Market that is just now completing a classic “mid-cycle” correction, the current readings support a bullish argument going forward over the next few months and possibly beyond.

S & P 500 and Broad A/D Line

In addition to the CBOE Options A/D Line, I maintain a broad A/D Line on a daily basis for a list of nearly 1,500 common stocks (all operating companies). While it is true that this gauge has declined to the low end of the range seen over the past two years thus far, this gauge has NOT broken down and taken out the important lows of October 2005. As a result, with the A/D Line still holding in the vicinity of previous medium term bottoms, it is very difficult at this point to conclude that a down-trend (i.e. Bear Market) is in effect.

S & P 500 & McClellan Summation Index

As long term readers know, for years I have tracked the McClellan Summation Index and in recent years have expanded the number of stocks in my universe from around 500 up to 1,500. The present list of nearly 1,500 operating companies embodies the lion's share of the market capitalization for all U.S. equity markets as the largest cap companies are all present in this unweighted index. Updating the Summation Index for the new, broader list of 1,500 stocks, we see that the indicator has been historically overbought with values above +4,000 (upper line), neutral near zero, and oversold with values below –3,000 (lower line).

Put another way: in the past, BEAR MARKETS and MAJOR CORRECTIONS have very often come to their end with the Summation Index below –3,000. This is NOT a short term or even medium-term gauge, but is instead a medium to long-term tool. As a result, readings below –3,000 on the Summation Index tend to imply serious stock market rallies, not stock market rallies that last a few weeks, but stock market rallies that last many months or more.

We have not seen a Summation Index value below –3,000 since March 2003, the kick off of the most recent three years advance. So where are we now? Last night, the Summation Index closed at a reading of –2,608.08, down from Friday’s reading of –2,396.04. With the McClellan Oscillator ending last night at a –212.04 reading, it means the Summation Index (a moving sum of the oscillator) is moving to the downside very rapidly and could easily be below –3,000 over the course of the next two to three market days.

What does this imply? Going back over the last 18 years, we find a veritable “Who’s Who” of market bottoms unfolding below –3,000. Granted, some of these bottoms, like the 1987 Crash and of the July 2002 Bear Market bottom, did end up achieving readings as far down as –6K to –8K. Yet, by far the majority of the readings below –3,000 were at levels not far below levels that are now being approached and invariably those readings all produced very major stock market bottoms.

While none of the discussion so far, precludes the possibility of a “Bear Market”, what I can say is that at least so far, there is no compelling case to be made that equity markets have entered into a bear market.  In fact, over the balance of the last 20 years, this is the first time we have seen the Summation Index challenging the low end of its historical range wherein the S&P 500 and DJIA have NOT seen a 10% or greater decline. In my view, the fact that the stock market is this oversold after a relatively modest price decline tells me there is an excellent chance that the market can “dig in” and record another “higher low”. In that event, we end up with a pattern of higher highs and higher lows, which spells continued “Bull Market.”

S & P 500 and Medium-Term ARMS Index

In addition to the Summation Index, the Medium Term ARMS Index or TRIN is also fully oversold. In my work, the ARMS Index is one of the best indicators at finding important bottoms as the gauge relates the amount of selling pressure taking place on the stocks that are going down, versus the amount of buying pressure which takes place on the stocks going up. When there has been an elongated period of heavy selling taking place on the stocks that have been going down, the ARMS Index advances and spikes upward across the range. That is exactly the kind of phenomena we have been seeing lately with the ARMS Index hovering above 1.30 over the balance of the last two weeks.

While the ARMS Index presently does not indicate the kind of total “abject fear” that was seen by the 1.60 to 1.70 type readings at the end of the 2002 Bear Market, it is fully comparable to the kinds of readings which have marked a number of bottoms in the Bull Market climates that have dominated over the balance of the last 20 years. Over the next few days, we will see another round of low take-away values coming off this gauge which should move the index higher even if the market moves up. To date, the highest reading seen so far was a value of 1.38 on May 30^th, which is in the same ball park as other important bottoms such as 1998 (1.47), October 1999 (1.41), late November 1994 (1.35), October 1992 (1.31) , December 1991 (1.35) and January 17, 1991 (1.35). To better illustrate some of these prior important lows, I include a close up view of the last 20 years worth of Daily ARMS Index values.

20 Years of ARMS Index Values

June 1997 - October 2001

March 1992 - July 1996

March 1988 - July 2001

NASDAQ Composite & Open 30 ARMS Index

In addition to the Medium Term ARMS Index shown above, it is also worth noting that the Open 30 ARMS Index for the NASDAQ market has also recently surged to multi-year highs. In the case of the “Open” ARMS, the indicator is “volume” weighted [meaning that high volume down days are required in order to drive it up across the broad range]. Looking back prior to 2000, the 1.00 value level for the NASDAQ Open 30 was invariably a bull market buying opportunity. Since 2000, we have seen something of an upward scale shift on this gauge with readings above 1.10 to 1.15 identifying important medium term lows.

During the worst phases of the 2001 to 2002 NASDAQ bear market, we saw two distinct spike moves to the upside with a cluster of readings peaking at 1.322 on 9/21/01 (Post 9/11) and a second cluster peaking on May 13, 2002 at 1.329. On June 16^th, this gauge reached all the way up to a value of 1.203 which represented the highest, most oversold value seen since the major lows going all the way back to October 7, 2002. In addition to the Open 30 – Medium Term ARMS, I also note the presence of very oversold values on the NASDAQ Medium Term Money Flow Oscillator. Here again, we are looking at a “bombed out” condition, where this oscillator recently moved down to touch values in the –320 to –350 range, wherein the “normal” oversold benchmark resides at levels of –200. For the NASDAQ, the recent low on this gauge at –354 on June 13^th represents the most oversold daily reading seen since the April 2000 crash (following NASDAQ 5,000) and believe it or not, a level MORE OVERSOLD than any reading seen during the course of the 2001 to 2002 downtrend.

NASDAQ Composite & Money Flow Oscillator

NASDAQ Composite with 200-Day Bands

Put another way, the NASDAQ is seriously overdone and from my point of view has to date not broken its longer term uptrend. In the daily chart below, we see that over the last few weeks, the NASDAQ Composite Index has moved from its upper 200-day Bollinger Band in May to the lower 200-day Bollinger Band here in June. Note that the lower 200-day Band is still in a rising configuration and that we are beginning to see positive divergences form on the 9-day RSI. Unless the NASDAQ were to move materially below the 200-day trading band, I believe the odds are very high that the index is close to a major low.

GST High Tech 50 Index and Summation Index

While we are on the Tech Theme, I also maintain a series of gauges on what I call the GST High Tech 50 Index, which is an index of 50 of the most important technology stocks. Among others, the index is comprised of Semiconductors, Equipment and Manufacturing companies, Networking, Software and PCs. Among some of the leading names, we find IBM, MSFT, INTC, DELL, AMD, TXN, ALTR, CSCO, AAPL, ORCL, ADBE, QCOM, MOT, KLAC, AMAT, HWQ, QLGC, EBAY and YHOO. In the charts below, I show the Summation Index for the High Tech 50 going all the way back to 1990 on daily basis, does this look like the area of a Bottom or Top to you?

GST High Tech 50 Index and Super "New" Trin

In addition, the Medium Term ARMS Index for the High Tech 50 is currently deeply into oversold condition with values near 1.50 over the past few days. Without exception, readings this high have always triggered sharp medium-term advances in the underlying index -- even during the great bear market of 2000-2002.

SENTIMENT:

Over the last few days, we have seen a huge swing in the sentiment indicators reflecting high levels of fear. These readings are unequivocally bullish for the stock market on both a short and medium term basis.

Advisory Polls:

While this is true of the majority of gauges that we track, of late the Newsletter Advisory polls appear to be lagging the market a bit more than we have seen in some time. Those surveys are probably the only area of sentiment that is NOT as empirically “hugely oversold” at the present time. Nevertheless, the message behind the bulk of the data is still unmistakably bullish as some of our more reliable gauges in this area (Advisory Opinion) are essentially at oversold benchmark levels.

S& P 500 and Investors Intelligence Survey

To begin with, we will review the Investors Intelligence Survey 5 Week Average of Bulls as a Percentage of Bulls + Bears which did dip last week to a reading of  .57 and will likely move lower this week toward readings near .50.

The Investors Intelligence Survey has been around the longest of all the polls and is usually a good place to start. In Bull Markets, readings of .50 on the 5-Week Average are very often associated with important corrective lows, but what strikes us as “odd” about this gauge was the lack of movement below .50 during the previous bear market decline in 2000 to 2002. That was an awfully big bear market and it didn’t generate readings below .40, the previous oversold benchmark. Going back to the late 2002 lows, the lowest reading seen was “only” a value of .46 on October 18^th 2002, - not that deep by historical precedent (see 1991 and 1994 and before that 1982, 1974). In addition, the Asia Crisis low and the 9/11 lows both occurred at values of  .46 and .50 respectively, again, not that deep. As a result, it appears that the transition away from “newsletter writing” has had the affect of compressing the scale on this gauge, which over the last 10 years has really resided between .50 and .70.

S & P 500 and Investors Intelligence New Oscillator

By that standard, we are heading rapidly for the low-end of the range. Allowing for the serious lags in the data, it should be oversold this week or next. In addition, because we have been noticing this trend in the II data over the last few years, we began experimenting with a second approach which compensates for the new range in the data. Using an oscillator construction, we derived the model shown below which is still predicated on the original II data series. Note that over the last few years, the data points on this timing model have been extremely accurate, with readings below –40 picking up the 1994 low, the 1997 low, the 1998 Asia Crisis low, the 9/11/2001 panic low, and the July 2002 panic low. At present, this gauge is down to the kind of extreme negative sentiment seen at those prior lows.

S & P 500 and the AAII Poll

Continuing with other Advisory Polls, we find additional confirmation of excess bearishness in the recent  action of the AAII Poll, where the four week average ended last week at a reading of –21.78, the lowest most oversold value seen since October 23, 1992 – over 13 years ago!

RYDEX FUNDS – Capital Flows:

With Rydex, the movement of the indicators reflects the movement of real assets, and in that sense, we feel this is an even better take on sentiment. In that spirit, we place a lot of weight on what we see happening below, namely, a broad scale movement back into the “Bear Funds” – How much money is back in the Bear Funds at the present time? Well, one of our favorite indicators shows the Assets in Bear Funds with the 200-day Bollinger Bands.

S & P 500 and Bear Ratio

Just look at the chart below and note the huge surge in Bear Fund Assets over the last two weeks. At present, Bear Funds are back up to the same levels seen as in the August 2004 low, the March 2003 Bear Market Bottom Low, the July 1999 low and are not far below values seen at the 1998 Asia Crisis low. This is a big deal and it tells us that sentiment is very bearish.

S & P 500 and Medium-Term Bear Fund Timing Model

Yet another approach we use with regard to the RYDEX FUNDS data is to compare the assets in the Bear Funds with those in Bull Funds. In our work, we use some technical smoothing and an oscillator approach to arrive at the Medium-Term Fund Timing Model which is shown below. While the curve is similar to the Bear Fund Assets, the two curves are not the same. Note that the October 2002 Bear market bottom in the model below shows up even more prominently on the Medium-Term Timing Model. That said, we are once again back to full-scale oversold values in the Rydex Timing Model indicating the likely presence of a major stock market bottom.

S & P 500 and Rydex Short-Term Model

In addition to the Medium-Term Bear to Bull Fund Model, I also maintain a Short-Term Rydex Model that has been and continues to be deeply oversold. On Monday, June 19^th, the Rydex Short-Term Timing Model closed at a value of  -35.64, down from –31.04 on Friday June 16^th. Historically, values below –25.00 have delineated very important short-term bottoms going back over the last five years.

S & P 500 and Frank's Dynamic Rydex Bull to Bear Ratio

In addition to my work with the conventional Rydex Funds, Rydex also transmits data on their Dynamic Funds which are geared to leverage a bet on either the NASDAQ or S&P. In the next Ratio chart I incorporate the Dynamic Fund data into the mix, and we arrive at the Dynamic Fund Ratio. Since these funds have less history, (newer products) there is not as much historical data to draw upon. Nevertheless, the Dynamic Fund Bear to Bull Ratio is still residing at the highest, most oversold levels seen since early August 2003, nearly three years ago.

S & P 500 and Medium-Term Rydex Model

With a little extra technical numbers crunching, I end up with my final Rydex Gauge which is a more Medium Term Model which is composed heavily of the Dynamic Funds. Again, what we see at the present time is a set of very deeply oversold values. In fact, this is the deepest set of oversold readings in the history of this particular model. What this tells me is that the stock market is extremely oversold and ripe for a strong advance.

S & P 500 and Option Gauges

Turning to the area of Options Gauges, these are still among the more interesting tools in evaluating market sentiment. They speak directly to what players are actually doing with their capital. As is often the case, ask someone what they think about the market and they may tell you one thing and actually be doing another. In my view, technical indicators that actually track “order flow” and what people are actually doing when they click on the mouse, is far more important than opinion-based surveys. In this vein, I continue to maintain an options database based on options traded solely on the common stocks of operating companies and by default this excludes ETFs ---which tend to fall into the domain of hedge fund toys where fancy options trading abounds.

S & P 500 and Operating Companies Only Put-Call Ratio

On the chart below, we see my Operating Companies Only Put-Call Ratio with three horizontal lines on the chart. The bottom line is the line denoting excess optimism at .60 which was closely approached with a daily reading of .61 on January 17, 2006. The second horizontal line, higher up on the chart is set at 1.10 which is the typical demarcation line for medium-term declines and oversold conditions. Over the years, many important lows, like the lows seen in August 2004, August 1999, December 1997, July 1996, March 1994, and July 1992 all bottomed with this gauge near 1.10. The next line up, the highest of the horizontal lines, is drawn in at 1.35 and this delineated more important, what we could call MAJOR LOWS. Here we see the twin bottoms of 1989 and 1990 up near 1.66, the Asia Crisis bottom in 1998 at 1.61 and the April 2000 NASDAQ CRASH Low of 1.48 on April 25, 2000.

Well, guess what?  On June 1^st, this gauge peaked at 1.602 and has remained in the 1.45 to 1.55 range ever since. What does this say about current market sentiment? In my view, it fully substantiates the extreme negative sentiment we see being manifested at the current time in the Rydex Numbers. Can you say important bottom?

S & P 500 and 50-day CBOE Put/Call Ratio

Continuing with our tour of the options world, I also believe there is strong bullish argument to made EVEN using the more conventional, widely-reported CBOE data, which I have not relied upon for quite some time. In my view, there is simply no doubt that this data series has been tremendously impacted by the rise of the hedge fund industry which uses option trading and more specifically hedged spread trading to a very heavy degree.

Notice that in the days when the hedge fund industry was smaller, from early 1990 thru 2000, the 50-day CBOE Put-Call Ratio oscillated between readings of .85 and .60. Readings above .85 spoke to 8 puts for every 10 calls, and too much fear, while readings below .60 spoke of only 6 puts for every 10 calls and relative high degree of optimism.

Notice that since the bull market of 2002-2003, the ratio has not moved back and forth across the same wide range that it used too, and instead has hugged the upper end of the range. In my view, this is a reflection of hedge funds shorting the puts, which is a bullish strategy but which nevertheless tends to artificially inflate the number of puts traded as there is no distinction in Put Volume for Puts purchased, a bearish strategy versus Puts shorted a bullish strategy. All of this notwithstanding, at the present time one thing is still painfully clear, namely – there have been a helluva lot of put options changing hands in recent days, re: the spike to the upside on the 50-day average which is now residing at new all time high territory. In my view, that just has to be a bullish indication and suggestion that the market has become too one sided in its view

S & P 500 and the Detrended 50-day CBOE Put-Call Ratio

Yet, we can go one step better, and get some type of relative feel for this data by plotting a 200 day moving average around the CBOE 50 day Put-Call Ratio. This is shown on the chart above.  Next, we can plot the current 50 day CBOE Put-Call Reading as an oscillator ABOVE and BELOW the 200-day average. By doing this, we reset the 200-day average as a kind of relative zero line and can compute a relative overbought and oversold value by plotting the percentage above and below the line. Using percentages keeps the data relevant across all periods of time and all markets. What we see here is a real eye opener.

Namely, as can be seen on the next chart, the Detrended 50 day CBOE Put-Call Ratio is currently well above its fully oversold threshold of +10% with readings over the last few days of  16.87 last  Thursday, 17.95 on Friday and 18.21 on Monday. Back in June of 2004, at an important market low the oscillator peaked at +18.12, so with Monday’s value of +18.21, we actually moved to the highest, most oversold value on this gauge seen since, ---- GET THIS, SEPTEMBER 21st, 2001 WHICH JUST HAPPENED TO BE THE DAY OF THE LOW FOLLOWING THE  9/11 ATTACK in 2001. To fresh everyone’s memory, on 9/11 (a Tuesday), markets immediately closed following the Trade Center attack with the S&P at 1092.55.

The market then reopened 7 days later on 9/17 and promptly tanked to a close of 1038.75. On 9/18, 9/19, 9/20 and 9/21 the market moved and continued straight down. On 9/21 the low was 944.75, representing a 5 day decline of 147.80 S&P points or 13.52%. From the May 2001 high at 1312.95 to the September 21, 2001 low, the market at that point was down 368.20 S&P points or 28.04% in 4 months.

Here’s the point. Back then it took a 28% decline over 4 months to generate a single day value of +21.47 on 9/21/01, and right now, we are currently within easy hailing distance of that reading at +18.21, and this market is “ONLY” down 7.69% on a closing basis, May high to June low. That’s a whole lot of fear showing up in the market very quickly and in my view argues an important bottom is at hand.

NASDAQ Composite and Detrended 50-Day CBOE Put-Call Guage

Another reference that is important to consider is the BEAR MARKET PANIC DECLINE OF JUNE-JULY 2002. Guess what? During that entire decline, the highest, most oversold value seen on the 50 day Detrend Put-Call Gauge was a single day value of +17.67 on June 21, 2002. Here again, we are already ABOVE that reading as of last night. What about some of the all-time high readings that were seen on this gauge in late 2000 and early 2001.

For the S&P, the decline at the time was relatively muted, leaving something of a puzzle with regard to the high Put-Call readings. The answer: back in late 2000 and early 2001, the high Put-Call readings came from a host of NASDAQ stocks that were in full blown collapse, as I highlight in the chart below using the NASDAQ Composite Index and the same 50 day Detrend Oscillator. Back then, that period marked the absolute brunt of the NASDAQ’s bear market decline, a veritable waterfall which produced abject fear. Believe it or not, we are actually within striking distance of those incredible readings and the readings seen in the +22 to +23 range at the bottom of the 1998 ASIA CRISIS.

S & P 500 and Put Volume Indicator

To get a numerical idea of the number of PUT OPTIONS actually traded over the last few weeks, I show the following chart of JUST CBOE PUTS over the last few weeks in context the level of options traded over the last 12 years. Can you see the parabolic spike in PUT OPTION trading? Sure, looks like there are a whole lot of shorts out there, maybe shorts ripe to be squeezed. Of course, it is possible that many traders were short volatility, and with down draft in recent weeks, have been looking to cover their low volatility bets. Of one thing you can be sure, the recent surge in the VIX Indices for both the OEX and the NASDAQ has been significant enough in historical context to suggest that the stock market has reached a relatively high level of fear. In our work, we track not only the raw data for both the VXO and the VXN, but maintain our own series of price-adjusted gauges shown on the charts below. In both cases, the recent readings are signaling the potential for a major market bottom and are echoing still other sentiment indicators such as the Investors Business Daily Premium Ratio, which is also down to long term oversold territory. 

Above: Total Put Volume CBOE last 16 years daily – note parabolic spike.

Above: OEX VIX Ratio, up to fully oversold levels. 

Above: GST Price adjusted VXN for NASDAQ – fully oversold.

Summary:

In closing, at present we DO NOT see enough technical evidence to this point in time to suggest that the recent decline in the major averages has altered the basic trend of the market from Up to Down.

With that in mind, we DO see the kind of fear and concern present (about the possibility of a trend change) with the consensus gravitating very quickly toward the idea that a Bear Market is now in force. In my view, with the consensus now heavily skewed to an ultra-bearish outlook and with many technical indicators either very close to or already at long-term oversold values, the odds of a major rally seem quite high in the weeks ahead. If an important stock market rally does not materialize, and instead prices move sideways while the current round of oversold readings dissipate, that scenario would be of much higher cause for concern.

For now, stock prices appear to be very close to a major bottom and could readily retest the low on the S&P in the 1220s range over the near-term (next few days). However, a “retest” of the lows on both the S&P and NASDAQ is primarily short-term in nature and appears to be the extent of the downside risk for now.

Looking beyond the pattern over the near-term, the odds appear to be building that a strong stock market advance could soon burst forth following the completion of the current base. If a powerful advance does take root, odds are high it will carry prices higher for months on end. Most of the time, the types of readings we are seeing now are normally associated with longer-term market bottoms and thus the stock market should be given the bullish benefit of the doubt. That’s all for now.