The stock market was a challenge to interpret last week. The
mid-week sell didn’t quite feel like the “blood in the streets” bottom and the
late week rally wasn’t all that convincing. We are not entirely convinced the
bottoms have been put in place for several reasons.
1 – Looking at the daily price chart of the Nasdaq and S&P
500, “The
Big Picture” section of Investor’s Business Daily points out, “The gains in the indexes were primarily the
result of a strong start. The Nasdaq was up 1.9% at midday and then gave back a
chunk of the advance as it met resistance near the 200-day moving average.
Bulls would’ve
preferred a strong close, but sustained gains in the indexes haven’t yet
developed. Four of the week’s sessions involved sell-offs in the late
afternoon.
Strong gains that fade
are typical in a market correction, and individual investors should respect
that reality”.
2 – Small cap stocks didn’t get the memo that Friday was a
risk-on day. The S&P 500 finished up 1.3% on the day. The Nasdaq and the
Dow Jones Industrial Average finished up 1.0% and 1.6%, respectively.
The
Russell 2000 small cap index finished the day a fraction LOWER. It seems a bit odd that a broad based market recovery would
completely bypass this sector. This action just didn’t “feel right” on Friday
and is a cause for concern as to the strength and longevity of this market
rebound.
3 – Volume for the S&P 500 was equally unconvincing on
Friday. One would anticipate a sharp bounce from an expected market bottom
would be on stellar volume and that wasn’t the case. One model that I watch
during period of tumultuous trading is our “conviction of volume monitor”. This
is a model works similar to a MACD model but uses volume action as opposed to just
price action.
The formula we use for this is as follows:
VO=(12Uema-12Dema)-(26Uema-26Dema)
VC= 9ema(VO)
We construct a volume oscillator subtracting the 26 period
(weekly) exponential moving averages for volume on all UP and DOWN days from
the 12 period (weekly) exponential moving averages for volume on all UP and
DOWN days.
We then take a 9 period (weekly) exponential moving average of this
volume oscillator to create a type of signal line that we call volume
conviction. For the sake of keeping the numbers in proportion we divide this
number by 1,000,000 for easier reading.
If we look back to prior market declines in 2011 and 2012,
one can find the VC oscillator trending lower prior to the S&P 500 decent. Both
times the model reached -1000 and started climbing, offering a gauge as to the
conviction of volume of the new market trend higher.
While the sell-off from last week felt unnerving, the VC
remains above zero and has barely registered any downside momentum. This action
is a bit unusual. That said the model has its fallacies and indicated periods
of stress in 2013 that turned out to be nothing. Perhaps this is another buy
the dip opportunity…perhaps it’s something more. Notice the series of lower
highs and lower lows during the entire 2013 and 2014 rally.
Judging from the pattern of this model, we are expecting
additional downward pressure that will at the very least bring this model into
negative territory.
4 – Admittedly I am not market technician, but when I look
at the daily price charts for both the S&P 500 and the Nasdaq, I see
resistance at the 200-day moving averages. Given the force that powered the
indexes through these averages to the downside, my initial thought is that it
may take equal force to penetrate these new upside barriers. Time will tell.
5 – The percentage of stocks in the S&P 500 trading
above their 50-day moving average is 19.8%. This is a level that has
accompanied past market declines, but rarely do we see an immediate bounce from
these levels to start a new rally.
We prefer to see this ratio sit and
consolidate around 13.2% (minus two standard deviations) for a period of time
before starting the next leg higher. The model may rest and consolidate for
some time at these levels (as markets continue to struggle) before the new
rally starts. Of course there have been times of a “V” shaped decline and
recovery and this could be one of them. This investor tends to think not.
6 – The VIX and the S&P 500 is known for their inverse
relationship. We like to track the sensitivity of this inverse relationship
using beta. As seen in Figure 6, the sensitivity figure has bottomed pretty
dramatically and has started higher. It also appears that the long term trend
line is starting to head higher which is an ominous sign for the longer-term
prospects of the market.
Bottom Line: Not to
sound too unsympathetic to those that have suffered losses in their portfolio,
this investor is favoring further weakness in the market in the hopes for
seeking value in new investment opportunities. In our opinion, our initial
analysis warns us that the market lows have yet to be reached.
Joseph S. Kalinowski, CFA
@jskalinowski
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