Tuesday, January 19, 2016

Trading Notes, Week of January 18, 2016

Friday, January 22nd

*  Yesterday's post noted the possibility that we had put in a momentum low for the recent market cycle.  Price action on Thursday was supportive of that hypothesis, as we saw very significant selling pressure in the afternoon, with multiple NYSE TICK readings below -1000.  That was similar in selling intensity to the puking we saw at the price lows, but now we were holding higher in price.  The market's ability to make higher price lows and higher highs is what we look for if we've indeed put in a momentum low.  Meanwhile, we've moved higher overnight, again consistent with the momentum low notion.  (Note the recent significant strength in oil prices, as well).  Bottom line is that, short-term, we appear to be transitioning from a "sell the bounce" to a "buy the weakness" mode. 

*  Here's a nice view of breadth among SPX stocks, which tracks the number of stocks making 5, 20, and 100-day new highs vs. lows.  Note how we've stayed oversold far longer than during recent declines; also note how we're still in oversold territory despite the recent bounce.  I expect stronger breadth numbers before we see a test of recent market lows.

*  Yesterday was the first day in 11 sessions in which we registered fewer than 1000 stocks across all exchanges registering fresh monthly price lows.  Still, only 46% of SPX shares are trading above their 3-day moving averages and only 31% above their 5-day averages as of yesterday's close (data from Index Indicators).  Those short term breadth measures should continue to strengthen if we've indeed seen that momentum low.

Thursday, January 21st

*  We saw concentrated selling early in the day followed by a vigorous rally with significant buying strength that erased much of the day's losses.  The breadth numbers were particularly extreme with 44 stocks registering fresh monthly highs against 3250 new lows.  The depth of the oversold condition, combined with the vigor of the buying, opens to the door to the hypothesis that we've put in a momentum low for this downward cycle.  With the reaction to the ECB meeting most recently, we've moved higher in trading.  We should see further upside follow through and divergences in the breadth data on further weakness if, indeed, we've put in a momentum low.

*  That being said, to reiterate a point made for a while now, this cycle has been deeper on the downside than cycles over the past two years and is more consistent with downward moves in 2010 and 2011 than 2014 and 2015.  These deeply oversold declines in 2008, 2010, and 2011 eventually went on to make further price lows well after the momentum point at which we'd maxed out the number of shares making new lows.

*  Here is an overbought/oversold measure that I track based on event bars rather than time-based bars.  What I look for in a bear market is overbought levels at lower price highs; those are often good regions for shorting.  In a bull market, you look for oversold levels at higher price lows.  Those are often good areas for buying.  In a range market, you'll see successive overbought and oversold levels at similar price extremes.

Wednesday, January 20th

*  Stocks came well off their highs during trade Tuesday with accompanying oil weakness and that weakness has continued in overnight trading.  That has taken us to new price lows and pretty well negated whatever divergences we were seeing in the data, as noted yesterday.  The important tell in Tuesday's trading was the inability of rallies to sustain either in time or price, as we made successive lower highs.  If we were coming off a momentum low, we'd expect to see value buyers sustain buying.  When buying is not sustained, there's a good likelihood that it's more short-covering than initiative interest.

*  Meanwhile, whether you look at VIX, volume, or the pure volatility measure that I follow (volatility per unit of trading volume), all are elevated, but none of seen the kinds of capitulation spikes that have characterized past sharp declines.  A break of the 2014 and 2015 lows may help yield such spikes; it's something I'm watching for.

*  Once again, to emphasize the themes from last week's notes, there is every evidence that this decline is different in character from the corrections we've seen during the past two years.  Oversold levels that had led to sustained rallies--characteristic of a range trade--are no longer finding buying interest.  It is difficult to imagine sustaining a move higher until we can find a bottom in oil and related commodities.  

*  It is also difficult to imagine the Fed sustaining a program of rate hikes in the face of deteriorating financial conditions.  The market decline is getting to the point where it will dent consumer confidence.  Note the superior relative performance of utility shares.  Yield becomes attractive as a flight to safety, but yield is also more attractive if rates are likely to stay lower for longer.

Tuesday, January 19th

*  Everyone wants to trade with confidence and conviction, but that means that we have to keep mind and body in peak conditioning, especially during busy markets.

*  We traded to new lows for this move on Friday, but interestingly we saw the first evidence of divergences in the new lows data for SPX stocks.  For example, we had 129 more new 100-day lows than new highs on Friday, surprisingly short of the 167 differential on Wednesday.  Only 8.96% of SPX stocks traded above their 10-day moving averages on Friday, but that was still higher than Wednesday's level of 4.98%.  (Data from Index Indicators).  Among SPX sectors failing to make new lows on Friday were XLU, XLE, and XLV.  The relative strength of the XLE shares is notable, given the recent weakness in oil.  We've bounced well off Friday's lows in holiday and pre-market trade. 

*  Last week's trading notes observed evidence that the current market downturn has been more persistent than recent corrections.  When we've had significant declines in August, 2011 and May, 2010, we saw follow-through weakness even after a momentum low was reached.  I am open to that possibility in the present market.  If, however, we have indeed put in a momentum low, we should see more of a two-way trade going forward than what we've seen thus far in 2016.

*  My intermediate term strength measure, which takes into account 5, 20, and 100-day new highs vs. lows among SPX shares, opens the week in unusually oversold territory.  With VIX closing above 25 on Friday, we should continue to see meaningful volatility.