Oreo Cookies and the Stock Market
By Frank Barbera CMT. April 22, 2008
In today's observation, we take a moment to update the stock market outlook from a purely technical perspective. As a result, today's report is a bit chart intensive but seeks to characterize the current market from a technical point of view, using Breadth, Momentum Volume and Sentiment, the big four of TA and of course, the biggest of them all, price. When we look at the S&P 500, it is abundantly clear that last years August and November lows represent very strong price resistance for the S&P at the 1400 level. Closer in, this year's February and April highs have also seen four peaks including the one over the last few hours, in the 1380 area. Thus, this 1380 to 1400 range becomes a very important zone. If the stock market as measured by the S&P 500 can press above this resistance in the weeks ahead, there is a good chance that prices will continue to extend the bear market rally over the next few weeks into the summer months. Under this outcome, prices could be moving up toward the 1440 level, which represent a .618 Fibonacci retracement of the prior decline. In the near term, the 1325 to 1330 zone looks like strong support for the S&P and unfortunately, it would probably take a break below that support in order to provide real clarification that a continue upward move was aborting.
Above: the Bullish Case, the S&P stays range bound a few more weeks 1320 by 1400 and then presses higher, moving back up to the 1440-1450 zone into the summer as part of a larger B Wave advance.
The Bear Case:
Alternatively, if prices fail in this zone, and begin to slump back to levels much lower then 1330, then the odds will be high that over the next few weeks we will see the S&P move down and retest the lows in the 1270 to 1290 range. Under this second outcome, the odds would then be very high that all of the price action seen since the late January low was developing as part of a five wave triangle labeled (a,b,c,d,e). Very often, bear markets unfold into three distinct legs, labeled A, B & C. In the case of the current bear market, the entire decline from last September's high to the January low can be labeled as Wave A of the Bear Market. That would then leave open the possibility that from the January low, Wave B is forming a five-wave triangle between 1390 and 1270 in which case, Wave D to the downside should be getting underway right now.
Above: the Bear Case suggests a large B-Wave triangle which sub-divides into a five wave movement labeled (a,b,c,d,e) with minor wave C peaking now and minor Wave D to the downside getting underway. It will take a sustained break below 1325-1330 to confirm Wave D is in control.
Under the more bearish case, the odds would increase that the 1400 resistance will not be overcome and that by the end of the summer, early fall the major averages will be sinking once again to new lows as Primary Wave [C] to the downside gets underway. Ultimately, Bear Market Primary "C-Waves" are usually devastating declines, and in either outcome, this type continued bear market behavior is still ahead. Thus, whether we get the strong B Wave retracement outcome toward 1440 or the Failing Triangle outcome capped below 1400, either way, the current period looks to be the "eye of the hurricane" and NOT the "everything is fine/happy days are here again" outcome that so many on Wall Street are hoping for. Earlier this year, in a radio show conversation with Jim Puplava, -- Jim postulated the "Oreo Cookie" outcome for the stock market, which was a big dark decline, followed by a rally - the smooth, creamy filling (the center of the cookie) and then a second, big decline. On this score, I presently could not agree more, with this Bear Market Rally - the "B- Wave" representing the smooth creamy filling and a lull in the bear market downside action. For those new to the stock market, understand this is how markets act. Nothing ever moves in linear fashion and in the stock market primary trends develop in a two steps forward, one step back fashion. In a Primary bear market, the "B-Wave" phase is the counter-trend move that harkens back to the kind of climate seen in the prior bull, but it is only a mirage and inexorably can give way to a second, far harsher decline.
Above: the McClellan Oscillator and the S&P
Turning to the technical indicators, we see the McClellan Oscillator in the chart above which has been recording steadily lower peaks. At this moment, the push up to slightly higher price highs over the last few days looks like a negative divergence with the oscillator recording a lower high against the higher price high in the S&P. This is not a positive indication for the very short term trend and argues that prices could be vulnerable toward a test of support at 1325 to 1330 over the near term. The next chart is also a message to short term bullish traders to go slow, as this is the 20 day moving average of Advances-Declines. At the moment, it is approaching overbought readings with a value of +57 last night, but has not moved all the way up to the fully overbought +80 to +100 range. Thus, this is more of an early caution sign then an outright warning, and all by itself, it would not preclude the market from potentially moving higher, so we would rate this gauge as only slightly negative.
Above: the 20 day Average of Advances - Declines
The next indicator is the Volume based ARMS Index, which we consider to be one of the best timing gauges for the stock market. In our work, we use an operating company only universe of common stocks, totaling 1,500 companies. No ETF's, No Closed End Bond Funds, No Country Funds, none of the other technical "garbage" which pollutes the widely reported AP Data from which most technicians use to plot the ARMS and which no longer really works. Using a clean database, we see that the ARMS Index regularly highlights major market bottoms with "high" values above 1.25 and signals a need for caution and potential market tops with low values near .80, the lower horizontal line.
So where are we right now ? With a close of 1.065 last night, the Medium Term ARMS is just slightly above neutral having come down off the deeply oversold values seen a number of weeks back. Of note, we have NOT seen a .80 value, a true overbought value on this gauge since last June, and that is becoming somewhat overdue. Even accounting for the fact that Bear Market rallies might not peak as low as bull market values, what I call a bearish upward "scale shift", one would normally expect at least a reading below .90 BEFORE an intermediate term B-Wave had run its course. So far, that type of low value has not been seen, and thus, in our view, the important ARMS Index is suggesting that the stock market may try to move still higher. While attempting to identify short term swings is always an interesting exercise, in our view, the real message is simply to recognize when this indicator eventually drops down to a value below .90, and possibly close to .80 and understand that where ever the market averages are at that time, that will probably mark a very important stock market peak. When that happens, we will be paying very close attention and moving to a very defensive posture.
Above: the Medium Term ARMS Index
Moving on, we next update the view of the Cumulative Daily Advance Decline Line for the stock market, with the A/D Line barely moving up off the recent lows. This suggests that we are in a narrow stock market, where a few sectors are moving up nicely such as Energy, but where by enlarge most stocks are struggling to make substantial headway. This sluggish action on the A/D Line underscores the idea that like it or not, we are very definitely most likely in a Bear Market rally phase and NOT the beginning of a new Bull Market as a new bull market would see the rally lifting all boats and would show a much more vibrant response on the A/D line. That is AWOL at the moment, and big picture that is not a good indication.
Above: the Daily Advance-Decline Line
Above: 200 day Detrend Oscillator Daily Advance-Decline Line
The next gauge we update is the 200 day Detrend Oscillator based on the Daily A-D Line and its 200 day moving average. This is a much longer range gauge and importantly did move down to a fully oversold value at this January and March's lows. Having reached the depths of fully oversold values, one would normally expect a multi-week "snap-back" toward zero on this gauge which is actually still pretty close to the low end of the range. Here again, this argues that the stock market probably has more time to go, and will be able to enjoy some additional weeks of stability heading into the summer before a more meaningful peak is seen for the bear rally. Ultimately, as this gauge unwinds back up toward neutral values, at that point, we can start looking around for an important top. Right now, this argues that market could have more room to the upside, but at the least is not likely to break down below the 1270 to 1300 level for some time.
Next up, we update a few of our favorite Sentiment Indicators starting with the four week average of the AAII, American Association of Individual Investors, Sentiment Poll. As is the case with some of the prior gauges, we still do not see any sort of positive sentiment value on a four week moving average basis. As a result, with this gauge still in negative territory, we would be inclined to suggest that the conditions are not yet right for a more important bear market rally peak. During the last bear market, 2000-2002, the AAII poll moved all the way back up to the +30 range, which right now, is along way from current values.
Above: the AAII Survey, four week average
The same type of situation also prevails for the GST Put-Call Ratio based on operating companies only. Yes, we did see very oversold values near the upper trading band back at the lows in March. However, while the ratio has declined, showing less FEAR in the market, it is still nowhere close to the low end of the range. For the Put-Call Ratio, low values indicate a move to optimism and optimism is what we would expect to see at a more important bear market rally peak. As a result, we once again see evidence to suggest that the market most likely has not yet seen an important bear market rally peak.
Above: 10 day Put to Call Ratio Operating Companies only.
Above: Dollar Weighted Put-Call Premium Oscillator for the S&P 500.
Continuing along with sentiment indicators, we see the same type of message coming from the S&P Put-Call Oscillator above, which spiked up in March, reflecting high levels of fear and is now easing down off those highs. Yet, while the indicator has come down off the highs, it is still a good distance away from the low end of the range which would suggest optimism and the possibility of another market peak.
Above: Investors Business Daily 10 day Moving Average of Call to Put Premium Ratio.
Finally, we end with the 10 day Average from Investors Business Daily which coming off the low in March shot up to the upper band in a wild move toward optimism. Over the last two weeks, it has now mean reverted to the middle band. Typically, for this gauge, we would look for a divergent set up, one with prices at higher highs and the indicator making a failing lower high. Here again, while that set up may be seen in the weeks ahead, for the time being we do not see a huge red warning light on the stock market. As a result, we believe that the Bottom Line message for investors is to presume that (a) the current recovery phase for the stock market is a bear market rally and that (b) the counter-trend movement phase has more time left in it, and potentially more upside.
On the matter of upside potential, that is most in doubt, but we would not be looking for anything but a stable market through May and likely, at least into early June. For traders this means that stocks may afford good opportunities for "hit and run" trading on the long side, and occasional quick trades "in and out" on the short side. At the moment, where the primary trend of the market is concerned, expect, at worst a neutral trading range and if prices do manage to close above 1400, the rally could extend in a material way toward 1440-1450. Either way, there seems to be more "filling" left in the Oreo cookie.
That's all for now,
© 2008 Frank Barbera