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Take a chill - part II



Last week at this time, I outlined how the market as defined by the S&P 500 (SPX) was oversold over the near-term (daily), but was not at levels over the intermediate-term (weekly) that have kick started prior meaningful and sustainable countertrend rallies. Despite the choppy conditions over the past week, the charts continue to basically say the same thing.

From a near-term perspective, the market may be oversold, but it has broken support (Exhibit 1) and in the context of a primary bear market - oversold normally becomes more oversold until an intermediate-term washout occurs. The most recent examples are last July and October's low, when all the time frames agreed that the market was oversold and washed out.

After three years of the bear, many market watchers know this and are looking for signs of an intermediate-term oversold condition. At first glance, the sign is there as the stochastic (most widely followed indicator) has now dipped into extreme oversold territory (Exhibit 2). Be careful to take to close a note to the initial oversold condition - even on the weekly charts - because the last time the SPX hit this level of oversold, it was a terrific sell signal. The market declined over 20% from the initial oversold reading. I don't think the same will happen here, but the recent memory certainly suggests waiting for confirmation from the other indicators such as the MACD, RSI, % below 200-day moving average and VIX (Exhibits 3-6). As a matter of fact, the weekly MACD may actually be offering a sell signal vs. an oversold washed out buy signal (Exhibit 3).

I want to reinforce that the market appears to be setting stage for another intermediate-term low that allows for a countertrend rally that lasts longer and goes further than most expect. My main point is that there is no evidence the low point is here yet and, as a result, suggesting that the market may be near the low could be right in terms of time (could be within weeks) but may not be in terms of price. As a result, buyers are likely to stay sidelined for the time being.

Exhibit 1 - So far, oversold has become more oversold after support was broken.

The Stochastic Oscillator compares where a security's price closed relative to its price range over a given time period. It is displayed as two lines. The main line is called SK Fast. The second, called SD Slow, is a moving average of the SK Fast. The reason that the lines are called fast and slow is because the SK line will always turn before the SD line, thus making it fast.

Exhibit 2 - Be careful to pay too much attention to oversold - even on weekly chart.

Exhibit 3 - The MACD does not confirm oversold and may actually suggest sell signal.

The Moving Average Convergence Divergence indicator is calculated by subtracting a 12-period exponential moving average of a security's price from a 26-period exponential moving average of its price.

Exhibit 4 - RSI also not at levels suggesting sustainable bounce yet.

The name relative strength is somewhat of a misnomer since the RSI does not compare the relative strength of two securities but rather the internal strength of a single security. A more appropriate name might be "Internal Strength Index".

Exhibit 5 - Still need larger spread between price and moving average to get overly excited.

Exhibit 6 - Volatility index likely needs one more push higher.

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Man do I have a face for radio - Doing an hour long spot on Bloomberg Radio from 9-10am EST.
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