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As many Minyans know, I track the percentage of overbought vs. oversold stocks in the S&P 100 (OEX) and NASDAQ 100 (NDX) each morning before the opening. Frankly, it has been the single best indicator I have used throughout the current bull tape. The percentage of overbought stocks peaked in mid-Oct and we have been thinking more meaningful consolidation/correction process since then. Despite weakness and strength since then, the percentages have not seen an extreme that would have brought in sustainable buyers.

As a result, we have focused more on the correction process than we have in the past few months. That process is well under way. As we outlined in our Hong Kong Fooey II report, the painful side of a correction can come well after the process has already began. We also highlighted how each time a meaningful correction takes place, it feels like something that will get much worse.

The current fears affecting near-term psychology surround the weak Dollar and surging Gold and Energy prices. The concerns are real...but we have seen them a number of times this year. In our view, the fears should be enough to cause the SPX to move toward 1,000. Since good news wasn't enough to draw in buyers since October, it was clear some fear and price deterioration was required to "bring 'em back."

Would a 5% drop be enough? It seems so given the amount of angst that has taken place due to a drop from 1060 to 1035. In a lower volatility environment, a 5% decline is likely to feel more like a 10% decline would have a year ago. In my view, if the market is topping, we should see it on the retest of 1060 and not on the first decline from a 52-week high.

Today's overbought/oversold readings are:
OEX: OB=29%, OS=24%
NDX: OB=20%, OS=27%

The internal readings of the market are rapidly moving toward the oversold direction. Again, we are looking for overbought readings to drop below 20% (preferably 15%) and oversold readings to rise to over 50% before expecting a sustainable rally. A bounce day is always possible, but a bit more correction should be needed to draw in sustained buyers.

As always, I offer this in a purely educational manner and do not intend it as advice.

No positions in stocks mentioned.
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