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In last week’s missives, I discussed the potential for an oversold, short-covering bounce which was to be used to further rebalance portfolios and reduce equity risk. The target zone was 1940 to allow for the completion of the “risk reduction” process.

“That rally could take the markets back to the previous resistance of 1940 (about a 4% push) from current levels. Such a rally would be enough to suck many of the “bulls” back into the markets pushing markets back into overbought territory and setting up the next decline.”

Chart updated through Friday’s close:

The good news is that the market was able to break above 1940, and the 50-dma, which now clears the way for a push to the 1970-1990 where the next levels of resistance will be found.

The bad news is that the markets are once again extremely overbought and still confined inside of an overall downtrend.

Importantly, as I predicted last week, the 200 and 400-dma has crossed into bearish territory for the first time since the financial crisis. While such a “cross” is not necessarily a signal of the onset of a new cyclical bear market, it does apply yet another level of downward pressure on stock prices. 

The next chart lays out the most probable path of the current bull rally within the confines of an overall bearish trend.

There are quite a few moving pieces here, so let me explain.

  • The shaded areas represent 2 and 3-standard deviations of price movement from the 125-day moving average. I am using a longer-term moving average here to represent more extreme price extensions of the index. The last 4-times prices were 3-standard deviations below the moving average, the subsequent rallies were very sharp as short-positions were forced to cover.The vertical blue bars show the previous two periods where bulls regained footing and pushed markets from lows towards new highs. The current setup is indeed similar to those previous two attempts. All we are lacking is some serious “jawboning” from a Fed official about accommodative support to push markets higher.  


  • The bottom of the chart shows the overbought/sold conditions of the market. The vertical dashed lines show that oversold conditions lead to fairly sharp rallies. The recent rally, while the last week’s missives has responded as expected from recent oversold conditions. With the oversold condition now exhausted, the potential for further upside has been reduced.

  • With the 125-day moving average trading below the 150-dma, and with both averages declining rather than advancing, the easiest path for prices continues to be lower as downward resistance continues to be built. The arching dashed red line shows the change of overall advancing to now declining price trends. 
  • As I stated, such an advance would correspond with a rally within the ongoing downtrend and sets the markets up for the next retest of recent lows.

    But that is must my opinion. There were some really good confirming bits of technical analysis out this past week as well worth sharing with you.

    No Breakout For The Bulls

    Northman Trader had an interesting technical post on Friday showing the technical breakdown of the market from several perspectives. The first, as shown below, is that while the markets closed below the important 1950 level, it did manage to stay above the 50-dma but just barely.

    Importantly, Northy also noted the topping pattern I discussed above along with the critical support levels going back to March and October 2014 lows.

    But here is the most important point he makes:

    “$SPX monthly chart: Unless the $SPX has a miracle rally on Monday it will close the month not having touched its monthly 5 EMA from the underside for the first time since 2009:

    What Northy notes in the chart above is the same message I have discussed over the past couple of months. That message is simple:

    “The market is currently suggesting that the bull market began in 2009 has now come to its inevitable conclusion.”

    The Perfect Storm

    Erin Heim from Decision Point, recently penned an excellent analysis also suggesting that the recent bull rally is NOT the beginning of a new bull market cycle. To wit:

    “Indicators in all time-frames don’t always coordinate with each other, but I believe they are beginning to meld right now. I noticed each time-frame was becoming extremely overbought.

    The first chart shows the On Balance Volume Indicator Suite made up of the Climactic Volume Indicator(CVI), Short-Term Volume Oscillator (STVO) and the Volume Trend Oscillator (VTO). As I said, they don’t often peak at the same time. Dragging a vertical line across the chart, I marked overbought readings peaking at the same time. The result? A price top. But wait, it’s important to point out the green line. There are undeniable similarities in price pattern and indicators that preceded another leg up. However, note volume behavior (blue lines). There is a distinct difference. Volume stayed fairly even during the preceding rally and in this case, volume has been drifting lower.

    “Here’s a three-year chart using the Price Momentum Oscillator (PMO), Swenlin Trading Oscillator – Breadth (STO-B) and Intermediate-Term Breadth Momentum Oscillator (ITBM). These indicators don’t line up very often. The last yellow bar uses a short-term overbought peak for the ITBM with the same result.”

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