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S&Ps Don't Spring During the Summer


The pathetic MACD & RSI readings suggest that the rally's most recent leg was a bridge too far.


The Dow, S&P and NDX all ended May at new highs. Minyan Michael Santoli's Streetwise column in Barron's two weeks ago neatly summed up past, present and future: "Is this a moment to celebrate or lament, a sign of reassurance or foreboding? Probably all of the above."

In fact, despite each index starting June by celebrating a record high last Monday, the mood quickly soured in reaction to interest rate fears. Three months ago markets turned down sharply in reaction to other fears. That drop's lows were probed for three weeks before the rally resumed. Will this drop be similarly absorbed, or was the sudden downdraft foreboding of a difficult summer ahead?

Whichever course the market has chosen, it shouldn't be long before we know. History always repeats itself in the market; we chartists and technicians depend upon past being prologue for price action. But market history rarely repeats consecutively, so this drop should eventually last only days, or else months. In other words, if this drop isn't obviously bottoming and recovering within days, then it will probably default to lasting months.

Signs of bottoming will be seen among technical indicators that measure price momentum, especially now that there has been a one-week swing of 3% or more (basis S&P, from intraday high to low). Once a drop has exceeded 3%, the leg isn't likely to be retraced until MACD & RSI have become "oversold." Notice the nearby S&P chart from the last big drop. RSI fell to oversold levels on March 5 - not necessarily ending the drop, so much as making it vulnerable to ending. The oversold market bounced as oversold markets tend to do, and then the oversold bottom was retested as oversold bottoms tend to be. S&P printed a new low intraday but MACD & RSI diverged positively, which buyers soon exploited, and continued exploiting through last Monday's record high.

Fast forward to the market's current challenge, which has also fallen more than 3%. The chart below depicts RSI, which is far from becoming oversold. Even in the event that last week's high were retested before S&Ps shed another tick, the 3% rule would have predefined the retest as just that - a retest, and not the rally's resumption.

A retest of last week's high would allow older, lower-priced data to be replaced by more recent higher prices. As a consequence RSI could become oversold more easily, without requiring S&P to dip much further than last week's lows. This doesn't mean a bottom would appear sooner - only that a bottom could appear sooner.

The above scenario would require Friday's bounce to extend higher this week, almost without any delay. But as of this moment there has been no such signal. Instead, the active pattern says Friday's bounce already corrected the S&Ps mid-week drop, and the decline can now resume to lower lows. A higher high intraday is irrelevant; a higher close would begin to invalidate the correction scenario, while a new relative low close would confirm it.

Refer back to the nearby chart, this time noticing the highlighted "Pivotal Correction." The setup forms when any four price points align as shown: A high and a higher high (Points 1 and 3, respectively) followed by a drop (Point 4) under their interim low (Point 2). Point 5 is currently in the making, and still has some room if needed. But now that Point 2 has been retraced, the next downleg is free to begin.

The next downleg's target can be defined more precisely while the leg develops and offers more clues. The leg's measurements are derived from a combination of the high, low and close from Points 1 and 4. Any two points are then extended by 61.8%, 100% or 161.8%, depending upon those forthcoming clues. The most likely targets are noted.

Summer rallies are rare, and not generally good bets. It's difficult to generate sponsorship for trending either way during the summer. The pathetic MACD & RSI readings at May and June's highs (depicted in the above chart) suggest that the rally's most recent leg was a bridge too far. The same readings at February's high allowed March's lows to serve as a buying opportunity. The season has since changed, and the next buying opportunity might still be another season away.
No positions in stocks mentioned.
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