Can You Bank On A Stock Market Bottom?

Can You Bank On A Stock Market Bottom?

December 30, 2018: Prior to last week’s action many of the technical and sentiment measures that I follow had reached extreme levels not seen in the past ten years. One such measure uses the NYSE Advance-Decline data. The chart from last week (Will There Be A Not Going Out Of Business Rally) showed that the 10 week moving average closed on Friday December 20th at -722. This was the lowest reading of the past ten years as it was below the lows from the financial crisis in 2008 when it reached -64.

Option traders had also become very bearish on the market. The Total Put/Call ratio is a combination of the index and equity options. A reading of 1.0 means that an equal number of put and call options have been traded. A reading of 2.0 means there have been twice as many puts traded as calls.

This ratio reached 1.83 on December 20th, (point 1).  This long-term chart shows the ratio going back to 2002. The ratio reached 1.68 in August 2015 (point 2) just before the stock market low. During the sharp three week decline in February 2007 (point 3) the Total Put/Call ratio had multiple reading above 1.68. During the last bear market it never exceeded 1.50 even during the fall of 2008.

The major averages finally responded last week to these extremes, but that was after the worst pre-Christmas decline ever as the S&P 500 lost 2.7% on Monday. By the close every sector was lower for the year. The market tone changed dramatically on Wednesday as stocks accelerated to the upside in late trading as the Dow Industrials closed over 1000 points higher.

The wild ride was not over as on Thursday the Dow went from being down 2.67% to close up 1.1%. For the week the Dow Industrials were up 2.8% while the S&P 500 gained 2.9%.  The tech-heavy Nasdaq 100 was up 3.95%.

Does this mean that the worst of the selling is over and that buyers can safely step back into the stock market? That was the view of some in the financial media, but is that consistent with the technical and sentiment readings?

In light of the prior week’s action the latest survey from the American Association of Individual Investors (AAII) was surprising.  The bullish% rose 6.7 points to 31.5% while at the same time the bearish% increased 3 points to 50.3%.  As the chart indicates the bullish% had a low the week of December 13th of 20.90  which was close to the lows last seen in early 2016, line a. Last week the neutral% was 18.2 which was the lowest reading of the past five years.

The bearish% was the highest in over five years as it only reached a high of 48.74% in early 2016.  It rose close to 55% in the spring of 2013 as the market had a brief pullback before it finished the strongest year of the bull market.  In July 2010, as the stock market was completing its correction, the bearish % rose to over 57% which was an excellent buying opportunity as the A/D lines had bottomed.

Even though the sentiment levels have reached levels consistent with a correction low, these levels need to be confirmed by technical signs of a bottom as they were at the February 2016 low.  The daily chart of the Invesco QQQ Trust (QQQ) shows the drop last week to a low of $143.46 as the daily starc- band was reached. This was a sign that the market was in a high risk sell, low risk buy area.

The QQQ subsequently rallied back towards the 20 day EMA which is now at $157.16 and represents further resistance.  There is even stronger daily chart resistance in the $169-$170 area, line a. By the close Friday QQQ was 6.6% above the lows, but the Nasdaq 100 Advance/dDecline line is still below its declining WMA (in green). It is also well below the downtrend, line b, and shows no signs yet of a bottom. The weekly Nasdaq 100 A/D line (not shown) is also still below its WMA and negative.

The 10 day MA of the Nasdaq 100 Advance-Decline has rallied from an oversold level of -75 to -28.7. It has not formed any divergences but could on a drop to new price lows. When this oscillator approaches the +50 level it is getting overbought and is warning that the market may be ready to pullback.

Every week I review the advance/decline lines that measure the health of the NYSE Composite, Spyder Trust (SPY), iShares Russell 2000 (IWM) and the SPDR Dow Industrials (DIA).  All of the other daily A/D lines, like the Nasdaq 100 A/D line, are below their WMAs and therefore are negative.

Even though Google searches for recession have reached the highest levels since November 2009, last week’s economic data is not showing widespread weakness. Monday’s Chicago Fed National Activity Index and Friday’s Chicago PMI both came in higher than expected.

The Consumer Confidence Index did decline in December as it came in at 128.1 which was below the prior months reading of 133.7.  According to the Conference Board’s Lynn Franco, Senior Director of Economic Indicators, the index still suggests the “economy will continue to expand at a solid pace in the short term. While consumers are ending 2018 on a strong note Expectations are reflective of an increasing concern that the pace of economic growth with begin moderating in the first half of 2019.”

The chart from AdvisorPerspectives shows that the Index is still in a solid uptrend. Prior to past recessions the uptrends were broken several months before the GDP dropped significantly and the economy entered a recession.

The Dallas Fed Manufacturing Survey will be released on Monday and the PMI Manufacturing Index on Wednesday. They are followed by the ISM Manufacturing Index on Thursday and the monthly jobs report on Friday. Apparently the government shutdown will not delay this report.  I do think the longer the shutdown lasts, the more likely it is to impact the financial markets.

While last week’s rebound was impressive there are no strong signs from my analysis that the worst of the selling is over.  However I still believe that a stronger rally is likely in 2019 once a bottom is completed.

As I commented last week a “rally should take the S&P 500 at least 10% higher and a 15% move is not out of the question. If the S&P 500 does reach 2350, a 10% rally would mean a move to 2485, while a 15% rally could take the S&P to 2702. The S&P currently has strong resistance in the 2600-2700 area.” The S&P 500 had a low last week of 2346.58 and that low could hold.

My advice also remains the same as for those who are fully invested, the rally will be an opportunity to re-evaluate your portfolio. This will give you the opportunity to decide whether the level of equity exposure is too high.  Of course, the strength or weakness of the rally will be important as a weak rally will set the stage for a further decline.

For those not in the market, I would favor a dollar cost averaging program such as the one I recommended in April of 2016 when the A/D lines overcame the 2015 highs.  Make four equal dollar purchases each week in a broadly based equity ETF, like the Vanguard S&P 500 (VOO).  Once the daily market bottom is completed you will be able to clearly establish the risk for the position. The strength of the rally will help you determine how long the positions should be held. Those who made an initial purchase last week should make another equal dollar purchase this week.

In my Viper ETF Report and the Viper Hot Stocks Report, I provide my A/D line analysis twice each week with specific buy and sell advice. New subscribers receive six trading lessons for just $34.95 each per month.

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