Tuesday, March 11, 2008

An Oversold Stock Market Amidst a Crisis of Confidence

We've hit oversold levels (below -30) in my Adjusted Demand/Supply Index; as mentioned earlier, these levels have been associated with favorable returns 20 days out and overbought readings (above +20) have provided a nice heads-up for subnormal returns over that span. I generally act on these readings when we see a pattern of waning new highs in an overbought market and dwindling new lows in an oversold one. The new high/new low picture was mixed on Monday, with 20-day new lows across the NYSE, NASDAQ, and ASE exceeding the Friday level (223 new highs and 3318 new lows on Monday vs. 224 highs and 3150 lows on Friday), but 52-week new lows among NYSE common stocks, SPX stocks, and NDX stocks dropping from Friday to Monday.

Meanwhile, the crisis of confidence among financial issues continued unabated on Monday, which is one of those themes I've been tracking for overall market direction. The Cumulative NYSE TICK, which has been dreadfully weak of late, continued so on Monday--another useful gauge of daily market direction--no doubt reflecting sentiment among traders, who are seeing daily new lows among such stocks as GS, FNM, C, BSC, and MER. A look at the longer-term charts of these issues is truly harrowing: FNM has gone from about 70 in August, 2007 to under 20 on Monday; MER has been cut in half since June; and C has gone from 54 to under 20 in that same time period. Moreover, the rate of damage has been accelerating: C has moved from 26 to under 20 within the last two weeks; FNM has gone from about 30 to under 20; and MER has moved from 55 to 43 in that same span.

Nor has weakness been limited to financial shares. Among the 40 stocks in my basket (equally divided among 8 sectors from the S&P 500 Index), my measure of Technical Strength (short-term trending) is also at highly oversold levels that have typified recent intermediate-term market lows. Two of the stocks qualify as trading in uptrends, five are neutral, and 33 are in downtrends. The overall Technical Strength Index, at -2160, is near levels reached at the January market lows.

As the recent post emphasized, the selling extremes we've been seeing (such as those 3318 new 20-day lows) are consistent with a momentum low in the stock market (which tends to precede price lows), but to enjoy more than a bullish bout of short covering, we need to see confidence enter the financial sector and buying sentiment return to stocks overall (an upward sloping Cumulative NYSE TICK). I'll continue to watch those two tells for day-to-day market direction, even as I stay alert for evidence of dwindling new lows at these oversold levels and a potential market rebound.