MARKET CONTINUES REBOUND FROM OVERSOLD CONDITION -- NYSE REGAINS 200-LINE PACED BY MATERIALS AND ENERGY -- NYSE BULLISH PERCENT INDEX, HOWEVER, SUGGESTS THIS IS A BEAR MARKET BOUNCE

BULLISH PERCENT INDEX SUGGESTS A BEAR ... The most difficult thing to determine in market analysis is the difference between a market correction and the start of a bear market. They look pretty much the same. Prices fall to an area of chart support (usually around the 200-day moving average), get oversold, and start to bounce. In most cases, that's the end of the correction and another upleg starts. In rarer situations, the initial decline is just the first phase of a bear market. After the oversold bounce has run its course, the market starts down again. We now appear to be at the point where the market has suffered a sharp setback and is starting a rally attempt. Short-term indicators only tell us about the short-term trend which is oversold at the moment. That's why I've been relying on longer-term indicators to determine the seriousness of the recent market slide. One of those is the Bullish Percent Index. I last wrote about this indicator in an early May article headlined: "Bullish Percent Index Gives Another Bearish Divergence" (May 03, 2006). The purple line in Chart 1 is an updated version of the BPI for the S&P 500 while the green line is the S&P 500 itself. [The BPI is the number of stocks in an index that are in point & figure uptrends]. My concern in early May was that the BPI was falling while the S&P 500 was hitting a new high (see arrow). That type of negative divergence is usually a bearish sign for the market and give a correct warning of the market's May downturn. A closer analysis of the BPI line suggests that the recent decline may be more that just a downside correction.

Chart 1

BPI FOR NYSE FALLS BELOW 50 ... Chart 1 shows the BPI for the S&P 500 falling below 50 and undercutting the low formed last October. That's a bad sign for the market on both counts. To show why that is, however, I'm going to use the Bullish Percent Index for the NYSE Composite Index because that's the measure generally used for market analysis. Since the NYSE includes all stocks traded on the NYSE, it's also a broader measure of market trends. Chart 2 shows a chart of the BPNYA for the last four years. The general guidelines are these: readings over 70 (red line) warn of an overbought market condition. Major market tops usually begin from over the 70 level. Major market bottoms usually begin from below 30 which marks a major oversold condition (green line). The last time the BPNYA fell below 30 was in the fourth quarter of 2002 when the market hit bottom. Every downside correction that's occurred since the start of 2004 has started with readings over 70 (including the last one). The question before us is whether this is just another downside correction or something more serious. Which brings us to the middle line at 50. As I explained on May 6, the 50 level is the dividing line between bull and bear markets. As long as more than half of NYSE stocks are in uptrends, a bull market exists. When less than half are in uptrends, a bear market exists. The last time the BPI line crossed over 50 was in the spring of 2003 when the cyclical bull market began. The three market corrections since the start of 2004 bounced off the 50 line which acts as support during market pullbacks. This time, however, it is different. The BPI line has fallen below 50 for the first time in three years (see circle). That suggests to me that the recent market decline is more likely the start of a cyclical bear market than a normal downside correction.

Chart 2

P&F CHART OF BPNYA IS ON SELL SIGNAL ... Chart 3 is a point & figure chart of the NYSE Bullish Percent Index. [You can find line and p&f charts for all the major market indexes on the Stockchart Market Summary page under Bullish Percent Indices]. Notice the alternating columns of x's and o's. The x column represents rising values, while the o column shows falling values. A major buy signal is given when an x column exceeds a previous x column. The last two major buy signals were given in January and May 2003. An initial sell signal was given in May 2004. A more serious one was given this month (the number 6 stands for June) when the BPI fell below a previous low a 52. [The drop below 50 is also a bear market signal]. The rising blue trendline is a drawn at a 45 degree slope from the late 2002 bottom at 26. It's been broken for the first time since then. That supports the view that the recent decline is more than just a normal market pullback.

Chart 3

OVERSOLD NYSE BOUNCES OFF SUPPORT LINE ... Chart 4 helps to put the current rebound in the NYSE Composite Index in better perspective. The good news is that the NYSE is bouncing off a rising (green) support line drawn under its May/October 2005 lows (and has regained its 200-day average). The 9-day RSI line (on top) has formed a small "double bottom" in oversold territory under 30. That bullish divergence supports a short-term rally. [The last two times the RSI fell below 30 coincided with market bottoms last October and April]. The daily MACD lines (below the chart), however, have fallen to the lowest level in eighteen months. That makes the staying power of the rebound suspect. To be totally fair, I have to admit that if the recent decline is nothing more than a sharp downside correction, this is probably where a bottom would occur. And therein lies the dilemma. Is this the final bottom in a bull market correction, or just the end of the first leg down? Or as Winston Churchill might phrase it: Is this the beginning of the end of a "correction", or the end of the beginning of a new "bear market"? I lean toward the latter view.

Chart 4

SOME FIBONACCI RETRACEMENT LEVELS ... The next chart shows the NYSE Index regaining its 200-day moving average today. Unfortunately, upside volume over the last two days hasn't been impressive. A new uptrend usually needs heavier volume on up days. I've overlaid Fibonacci retracement lines on the daily bars. A normal rebound could carry to the 38% to 50% lines without disturbing the downtrend. A move over 8300 (the early June peak and the 62% line) is needed to signal that the market is out of danger. The fact that basic materials, energy, and precious metal stocks led today's market bounce is encouraging for the bulls. They've been the market's weakest groups of late. Chart 6 shows the Materials Sector SPDR (XLB) climbing back over its 200-day line as well. The daily RSI and stochastic lines are turning up from oversold territory. The jump in commodity-related stocks coincided with a jump of nearly six points in the CRB Index which also closed back over its 200-day line. With global stocks also on the rebound, it looks like the worst is over for the time being for commodities and stocks. Now it's a matter of monitoring the price and volume action to see if the rebound has any legs.

Chart 5

Chart 6