Sunday, August 23, 2009

Indicator Update for August 23rd

In the recent sector update, we saw that the eight S&P 500 sectors that I track weekly are all showing bullish short-term uptrends. Now we take a look at market status with two of the intermediate-term indicators of strength and momentum that I find most helpful.

The first is the Cumulative Adjusted Demand/Supply Index (DSI; top chart). This takes the proprietary Demand/Supply numbers posted each morning via Twitter, subtracts the prior 20-day average value from each day's reading, and adds the result as a cumulative sum. This turns the short-term momentum measure (which tracks the number of stocks closing above and below the volatility envelopes surrounding their moving averages) into an intermediate-term one.

Note how the DSI hit an oversold level on Monday that was similar to the readings registered at the March and early July lows. We have since moved steadily higher, and now are seeing fresh bull market highs at lower levels of momentum. There is room for DSI to move higher before it hits overbought levels, so it would not be surprising to see higher price highs in the days ahead. Indeed, in a bull market, we'll typically see prices hold relatively steady on pullbacks in DSI and forge higher on further "overbought" readings.

That having been said, we're seeing progressively lower highs in DSI from the March strong rally to July's move to new highs to the present. Should we begin to see toppy readings in the raw Demand/Supply Index itself (drying up of Demand even as prices stay firm) at current Cumulative DSI levels, that would suggest that the rally is petering out. With Demand at 166 and Supply at 21 as of Friday's close, that toppiness is not occurring at this time. We have to stick with the short-term upside momentum until the market shows us that it is waning.

Like momentum, the number of stocks making fresh 20-day highs vs. lows (bottom chart) is at notably lower levels at Friday's price highs than it was early in August. Indeed, we saw 1903 65-day highs on August 3rd, but only 1242 on Friday. This suggests that the rally's base may be narrowing, something we tend to see during a topping process, not during the early phase of a market upleg. I will be watching new highs/lows as well as DSI very carefully early in the week to see if we accept value higher and build momentum for a fresh upleg vs. trap bulls and retreat into last week's price range as part of a topping process.

In my view, it's premature to be aggressively bearish, given the market's short-term uptrend and short-term upward momentum, but there are also yellow caution flags that make me hesitant to buy recent highs. We are making those highs on reduced momentum and strength, and that makes me quite cautious as a bull.

Longer term, the picture is clearer: We are seeing successive lows in Cumulative DSI at successively higher price levels. That is what bull markets do. As long as we're seeing higher price lows on each pullback in Cumulative DSI, the longer-term bull remains intact.