Monday, July 21, 2008

Indicator Review for 7/21

Last week's indicator review noted that the major indicators continued to be weak, but had stopped weakening, particularly among the small caps. The weakness continued into the early part of this past week, expanding the number of stocks registering fresh 65-day lows (middle chart), but not taking the Cumulative Demand/Supply Index (top chart) or the Cumulative TICK to corresponding lows. This suggested a loss of downside momentum and sentiment, even as the financial sector was selling off furiously. As I noted in my Twitter comment at the time, it was an unusual market, in that some sectors were in absolute panic selling mode, while the broad market was holding up surprisingly well (though weak).

The result was that we had a ferocious short-covering rally during the latter half of the week, which took us out of oversold mode (middle chart) and sent the Cumulative TICK sharply higher. As long as the TICK is in rally mode and we're getting improvement in the new high/new low data (top chart), it is premature to fade this rally.

As my recent post indicated, we've seen considerable sector rotation these past few days, with the weakest sectors (financial stocks; consumer discretionary issues) benefiting most from the short covering. At the same time, energy stocks, which had been performance leaders, have moved to the bottom of the pack thanks to a commodity-related selloff.

As you can see from the top chart, these oversold conditions in the Demand/Supply Index have tended to yield rallies of intermediate-term duration. So far, we're seeing lower highs during these rallies and lower price lows on the declines, which is the definition of a bear market. I am not at all convinced that we've seen the ultimate lows for this bear, but I've also learned not to fight the indicators when they're in sharp rally mode off a severely oversold condition.