Last week's indicator review noted that it was unwise to engage in bottom picking, given the expanding weakness across the majority of indicators. That proved to be a sound policy, as we hit fresh bear market price lows during the week. Three of the most important themes leading the market continued to point to weakness, and a heads up from the Chair alerted us to government intervention--first with IndyMac, then with Fannie and Freddie. The last large intervention--with Bear Stearns--stemmed a market decline in March and led to a respectable rally. Might that be the case this time around as well?
Interestingly, as the Fed made its intentions known, the indicators remained weak, but stopped getting weaker. As we continued to make price lows into Friday in the S&P 500 large cap stocks ($SPX), the Russell 2000 small cap issues held above their lows from early in the week. This was reflected across a range of indicators: on Friday, the number of stocks making 65-day highs minus lows held above the levels from Monday (top chart); the advance-decline line specific to NYSE common stocks (middle chart; credit to Decision Point) failed to move to new lows late in the week; and the proportion of NYSE stocks trading above their 50-day moving averages also rose as the week progressed (bottom chart).
When I examined the advance-decline line more carefully, a pattern emerged: the line specific to the S&P 500 large cap stocks made fresh lows on Friday, but the lines specific to the S&P 600 small cap stocks and the S&P 400 midcaps held above their lows. This lack of participation among the smaller issues was the first time in a while that the market weakness was not begetting more weakness.
As I noted on Friday, if this divergence is meaningful, we should see good buying off the lows early this week. So far, we are seeing a bounce in stock index futures as I write this, in response to the Treasury's support of the GSEs. I will watch the financial/banking and housing stocks particularly closely to see if the government actions stem the selling in these most vulnerable sectors. Also keep an eye on the consumer discretionary sector (XLY), which has borne the brunt of the market's recessionary expectations. Given the resilience of the indicators late in the week, it would not surprise me to see some sharp short-covering ahead, especially among these beaten down sectors. If that is going to happen, we should see some sustained positive action in the NYSE TICK; I'll be updating that indicator shortly. And, as always, I'll be updating some of my favorite indicators daily via the Twitter app, along with links to timely posts on key market themes.
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