Monday, July 28, 2008

Indicator Review for July 28th

Last week's review noted a sharp rebound in the indicators, as buyers flocked to the most beaten-up market sectors. As we can see from the Cumulative Demand/Supply measure (top chart), this rally has continued in the past week, taking us toward overbought status before a pullback late in the week. Such sharp rises out of a market bottom are typical for this indicator and generally precede price tops, sometimes by a considerable time period. It's when we see indexes making price highs with weakening Demand vs. Supply that we generally look for sustained reversal. After an initial upthrust such as we've had, it's generally worked out well to be a buyer on dips in Demand vs. Supply. Note that you can track daily Demand and Supply figures each morning via my Twitter posts.

A similar rebound is evident in the number of stocks making new 65-day highs vs. lows (bottom chart), as the vast majority of issues have come off their lows. As long as we continue to expand the number of stocks registering fresh new highs and don't see an expansion of stocks making fresh new lows, it is premature to fade market strength. (That same principle was instrumental in not fading the significant market weakness during June and the early part of July). The 20 and 65-day new highs/lows are also updated each morning via Twitter.

As you can see from the charts, however, we seem to be hitting overbought status at successively lower price levels in the S&P 500 Index, which is characteristic of longer-term bear markets. My recent analysis suggested that much of the bounce we've seen in stocks can be attributed to short covering and sector rotation, not an influx of new money coming into equities. Smaller cap stocks have tended to outperform larger caps of late; I would become particularly defensive should weakness from the larger issues infiltrate those smaller ones.

Longer term, of course, the market is anything but overbought, as we have only 26% of S&P 500 stocks; 39% of small caps; 36% of mid caps; 33% of NASDAQ 100 stocks; and 13% of Dow Jones Industrials stocks trading above their 200-day moving averages. Note again how the larger the index cap, the weaker the performance. Intermediate-term rallies of late--even during the recent market weakness--have tended to peter out after over 70% of stocks are trading above their 50-day moving averages. We're not near that point yet. That measure is also updated each AM via Twitter.

In summary, we have made a strong upthrust from mid-month market lows and have moved higher, as short-covering in weak sectors and a drop in oil and other commodity prices has been supportive for stocks. If precedent holds, this bounce has further to go, but so far the evidence points to the distinct possibility that it will only be a bounce in a larger bear market. Should the indicators show signs of weakening even as stock prices are in their bounce mode, I would become more aggressive in pursuing the downside. Should we test the mid-month lows with significant divergences among indicators and sectors, I would turn very strongly bullish.