The bottomline is this: the indices and most of the sectors have fallen under their key moving averages. Many of these now have a declining slope. Over the past month, price has made lower highs. All of this suggests that the trend is down. Moreover, bullish set ups are failing, a warning that price has not reached an oversold level. Despite the sell off, breadth and longer term measurements of sentiment have not washed out to an extent that would suggest a low is in place. Finally, the dominant pattern, which we will describe below, suggests lower prices are ahead.
Let's look at each of these points in turn.
The overall pattern continues to be extremely volatile. From last week's high, SPX dropped 3.7% to this week's low on Thursday. It then rose nearly 2% during the day on Thursday before losing 1.3% on Friday.
In the past several weeks, since December, SPX has lost 5%, gained 6%, lost 5%, gained 4%, lost 4%, gained 4% and now lost nearly 4% again. As we have said in recent weeks, we haven't seen this pattern in more than 3 years. At best, the pattern suggests indecision; quite possibly, it suggests that indices are in the process of changing trend (more on this in last week's post).
On Wednesday, selling was so strong that the NYSE advance-decline volume was 10:1 negative. This is a major distribution day. The very next day, TICK hit the highest level since the December low as buyers aggressively chased offers. Short term sentiment has been flipping from day to day, something to keep in mind heading into next week after another strong sell off on Friday.
Over the past 4 weeks, SPY has been in a trading range between 199 and 206. Just when it appears ready to break higher, it has sold off (like this week). It has reversed off of the low 4 times already, including this week.
The selling on Friday looks bearish. It would be remarkable if the 198.5 area held for a 5th time; more likely it will break and head at least to the December low under 197.
That said, until price falls below 199 again, we assume that we are at the bottom of the one month range where price has reversed previously, even if that seems unlikely. From Friday's close, the risk is less than 0.5%.
Above, 202 has been resistance; above 202 and SPY would likely backtest its 50-dma at 204 (both those levels are indicated with light blue lines above). Remember this is a volatile and fairly unpredictable market environment.
After touching its 20 weekly MA four weeks in a row (arrows), SPY finally closed below this week. The pattern has been for SPY to visit its lower Bollinger when the 20-wma breaks on a weekly close (yellow). If the one month trading range fails, our leading hypothesis is that SPY is headed to this area in the weeks ahead (currently at 190, about 5% lower).
SPX, NDX and DJIA have now closed lower two months in a row. This is surprisingly rare. Since March 2009, SPX has closed down two months in a row only three times: in 2010, 2011 and 2012. Only 2011 closed down a third month (it closed lower 5 months in a row).
You might think that this apparent strength is due to the Fed's QE program, but the same pattern was true in prior bull markets. During the 2003-2007 bull market, SPX never closed down more than two months in a row. This was also true from November 1990 to June 1999. More than anything, its a feature of a bull market.
This suggests a tradable low could be made in February.
What is notable this time is that the fall has been minor. From the end of November, SPX has only lost 3%. This brings up several points.
The first is that, since the late 1980s, none of these two months drops has ended until SPX has touched its 13-month MA (green line). It usually went much lower. That now stands at 1940, about 3% below Friday's close.
Second, the low of the second month has been usually retested or surpassed in the third month, even if that month closed positive. In other words, the negative momentum didn't end with the end of the second month, it continued into the third month. This suggests a lower low in February is likely.
Third, and perhaps most importantly, bullish sentiment in the past has been thoroughly deflated by the time the low has been put in. The current Investors Intelligence bull/bear ratio stands at 3.3x, meaning that there are more than 3 times as many bullish investors as bearish ones (blue line, far right). This makes sense; the fall so far has been minor and it comes after nearly a 100% gain in just over 3 years. But after prior lows following two month drops, this ratio has typically been under 1.5x and often under 1x (green boxes). We have excluded drops that occur during a recession (yellow; chart from Yardeni).
Bullish sentiment has been stubbornly high since 2013. The only comparable period, using the Investors Intelligence data, is 1987. It's a sample of one but that ended with a fall in SPX of more than 30%.
It is, however, important to recognize that bullish sentiment can be reset through price and time. A long period of choppy, sideways trading is just as effective at frustrating and turning investors bearish as a large drop. The current correction is in week 5. In 2005, SPX dropped only 7% over 7 weeks; enough to reset sentiment. In 2004, SPX also dropped 7% but it took 8 months to do so; also enough to reset sentiment. A large fall is not a prerequisite for resetting sentiment.
Since 2009, the pattern has been larger drops over a 10 week or so time period. In 2010: 16% drop over 10 weeks. In 2011: 21% drop over 13 weeks. In 2012: 11% drop over 9 weeks. Another month of choppy trading, heading down to lower weekly Bollinger (190) would equal the correction duration of 2010 and 2012 and very probably turn investors bearish.
All of the indices in the US are now under their declining 50-dma and 13-ema. NDX and SPX have descending triangles forming: lower highs with a flat bottom. This pattern forms when sellers are accepting lower prices with each bounce. These patterns normally break lower. For NDX, 4000 round number support aligns with its 200-dma, about 4% lower.
The pattern in DJIA is different. It's in a falling channel; price is at the lower end of this channel and also just 0.5% above its 200-dma as well as its December low. There might well be a positive reaction off this combined area early this coming week. Note: RSI downward momentum is waning.
What is noteworthy about the Dow is its breadth is nearing a wash out. A majority of lows have been formed when only 15% of Dow components are above their 50-dma; at the close on Friday, that number was 20% (lower panel). The Dow has often been higher within two weeks after a washout (green lines). It could happen this week on further weakness.
That is also the case with SPX. When only 20% of components are above their 20-ema, price has bounced the last two times (middle panel; dashed lines). It currently stands at 27%. At more significant lows, only 30% of components have been above their 50-ema; it currently stands at 39% (lower panel; solid lines). Both of these could be reached on further weakness this week. This is something to watch.
Note that there were two failures: one in October 2014 and the other in 2011. So reaching a wash out in breadth sets up a low but we need to see confirmation in price and other indicators.
Further weakness in February fits the seasonal pattern. February is the weak link in the otherwise bullish period from November to April. Returns over a variety of timeframes have been flat to negative (chart from Bespoke). Note that March and April are very bullish. Again, a low in February or into early/mid March should be a leading hypothesis at this point.
Like most months, February typically is weakest during the middle with more strength at either end. However, early February is not particularly strong (chart from Sentimentrader).
On the economic calendar, NFP for January is released on Friday. SPX has been up 21 of the last 26 NFP days.
Our summary table follows.
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