Wednesday, July 8, 2015

Another short-term bottom?

US equities are getting oversold again. Roughly a week after the last severely oversold signal (see Time for a market bounce?), I am seeing oversold signals all over the place.

In that post, I highlighted my Trifecta Bottom Model (for full details of the model see Time for a market bounce?), where two of the components had flashed buy signals, which sported a 100% batting average in the last three years. I have marked with blue vertical lines past instances where two of the three components have flashed buy signals and in red vertical lines past instances where all three components have simultaneously flashed buy at the same time.

Even though the last signal resulted in a wimpy 1% bounce in the SPX, here we go again with another buy signal a mere six trading days later.

To be sure, I would point out that the Trifecta model is an oversold model. During prolonged declines such as the ones we saw in 2010 and 2011, oversold models don`t necessarily work all the time because oversold markets can get more oversold.

Other signs of an oversold market
Besides my trusty Trifecta model, I am seeing other signs of a crowded short and oversold market. The CNN Money Fear and Greed Index fell to single digits at a reading of 8, which is a level where the market has bottomed in the past.

The CBOE equity-only put-call ratio has risen to 0.87, an elevated level indicating excessive fear while the SPX is testing a key support level.

Finally, this chart of the SPX shows that it breached its 200 day moving average, a key support level. However, RSI(5) is in oversold territory and showing a positive divergence. At the same time, RSI(14) is at the bottom of its 2015 range and stubbornly refuses to get oversold, suggesting that it is nearing a support level and may be due for a bounce.

How should we interpret all this? On one hand, the SPX violation of its 200 dma could be construed as a technical break and this could be the start of a cascade pointing to much lower prices. On the other hand, technical and sentiment indicators are flashing oversold signals which suggests that, even if we take the position that the intermediate trend is down, the market may need to stage an oversold rally first before falling further.

In all likelihood, we are on the verge of an oversold rally. Should it occur, the first logical resistance would be the 50 dma at about the 2100 level, but let`s take this one step at a time. Next week is option expiry week, which tends to lend an upward bias to stock prices. On the other hand, we do have the tiny detail that the EU may decide to blow up the Greek banking system this weekend, which is an event which could cause *ahem* a considerable reduction in global risk appetite.

Disclosure: Long SPXL


Unknown said...

I concur very good post. Add to this a China short squeeze. But how long is the long SPX good for? Long term China can't regulate their market forever. Gravity will take effect.

RAS said...

Perhaps, if you look at the $NYAD plotted on a cumulative basis, you'll see that it is approaching both its 200 DMA and the line of resistance formed by the falling bottoms starting back in the first week of May, which may be indicative of a turnaround in the offing. Also, the RSI is at 33.74, which is about as low as it has been since the market bottom last October, which may be another indicator of a potential bottom. But the MACD hasn't crossed above its signal line, so perhaps it is a tad premature to call the bottom. Also, although there has been a lot of chatter in regard to the markets melting down in Asia, the Greek situation has overshadowed it and so far, there's no "Asian Contagion" in the US markets. That could change if the market wakes up to the prospect of a severe recession in China and the rest of Asia, for which the Chinese market action may be acting as a leading indicator.

Anonymous said...

I would opine that whether the S&P 500 is oversold or not depends upon "what is the minimum length trend you want to follow and how much of a pullback in that trend are you willing to take in order to consider it still in a trend."
- Since you used RSI(5), then maybe you are using a trend length of 5 days.
- in which case then I'd say yes, we are currently oversold.

Cheers ... Peter

RAS said...

Looking again at the NYSE A/D line plotted on a cumulative basis:

it looks suspiciously like a classic head and shoulders pattern is developing. If that is actually the case, and the right shoulder develops over the same time period as the left, then the rally might have another six weeks to go. That's not a prediction, just an observation. I'll leave the predictions to wiser heads. As an empiricist, I just try to look at what the market is doing and go with the trend. Right now it's up. How long that will last is anybody's guess.