BANKS WEIGH ON THE MARKET -- BONDS CONTINUE STRONG -- RATES FALL TO NEW LOWS -- ANALYZING PAST CORRECTIONS -- APPLYING THE PAST TO THE PRESENT -- AD VOLUME RATIO SURGES
FINANCIALS WEIGH ON THE MARKET ... Today's Market Message was written by Arthur Hill. John Murphy will be back next week. - Editor
Continued concern over the sub-prime problems and the current credit crisis buoyed bonds and weighed on financial stocks-again. Barlays PLC reported that it will take a $2.7 billion write down. In addition, the CEO of Wells Fargo (WFC) said the nationwide housing decline was the worst since the great depression. The Finance SPDR (XLF) pulled back over the last two days to establish resistance from Wednesday's high. The ETF remains in a clear downtrend and it would take a break above this level to argue for a rally towards the next resistance zone around 34.
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BONDS SURGE IN FLIGHT TO QUALITY... The iShares 20+ Year Bond ETF (TLT) broke resistance in mid October and surged to a new 52-week high today. There is clearly an inverse relationship between stocks and bonds since mid October. During this time frame, stocks declined while bonds rose. The rise in bonds sent the 10-Year Note Yield ($TNX) to its lowest level since September 2005. The chart below shows TNX with a big double top. The break below key support at 44 (4.4%) confirms the double top and points to further weakness. Because bonds move counter to interest rates, this implies further strength in bonds.
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LEARNING FROM THE PAST... Technical analysis is all about learning from the past and applying these lessons to forecast the future. The S&P 500 ETF (SPY) bottomed in October 2002 and broke resistance in April 2003 to start a long-term uptrend. The ETF has been trending higher for five years now. Focusing on price action since January 2006, I identified three corrections that were greater than 6%. The red line is the ZigZag indicator set at 6%. It only moves when prices move 6% or more. Movements less than 6% are ignored. Since 2006, there have been four declines greater than 6%. We are currently in the fourth.
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COMMON CHARACTERISTICS OF A CORRECTION... Let's look at the prior corrections individually for some insights. The first correction occurred from early May to mid June in 2006. After a sharp decline, there was a reversal and surge in mid June. This was the initial surge. After a two-week consolidation, the ETF continued higher with a follow-through breakout. There was successful support test in July and then another follow-through breakout later that month.
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The next correction occurred in February-March 2007. After a very short and sharp decline (seven days), SPY formed an inverted hammer and surged back above 140 (initial surge). There was a successful support test later that month with a hammer reversal forming. The ETF then followed through with a breakout around 141.
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The third and final correction occurred in July-August 2007. After a sharp decline from mid July to mid August, SPY formed a hammer and surged above trend line resistance (initial surge). The ETF then pulled back and stalled for two weeks. The initial surge held and SPY followed through with a break above 148 (follow-through breakout).
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APPLYING THE PAST TO TODAY... Now let's apply the lessons from these corrections to the current decline. There are three stages to watch for: initial surge, successful support test or consolidation and follow-through breakout. The final stage is the most important. Surges, consolidations and support tests mean little without a follow-through breakout. SPY declined sharply from mid October to mid November. The ETF reversed course on Tuesday and surged above 148 with a strong move. This is the initial surge. SPY pulled back over the last two days and is now undergoing the support test. Wednesday's high becomes the important resistance level to watch for a follow-through breakout. A successful test of the November low AND a follow through surge above Wednesday's high would be quite bullish. I would also look for confirmation from the other major index ETFs and breadth.
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NASDAQ AD VOLUME RATIO SURGES... The next chart below shows the Nasdaq AD Volume Ratio for 2007. Surges above 9 show exceptionally strong buying pressure. This means that the volume of advancing stocks outpaced the volume of declining stocks by at least 9 to 1. The March low coincided with a surge above 15 and there was a surge above 9 just after the August low. The AD Volume Ratio also surged above 10 on Tuesday. Despite such strong buying pressure, it is tough to base a trend reversal on just one day. Therefore, I would suggest looking for some follow-through for confirmation. SharpCharts users can click this chart to see the settings and save it to their Favorites.
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NYSE AD VOLUME RATIO FOLLOWS SUIT... The next chart shows the NYSE AD Volume Ratio for 2007. The NYSE and Nasdaq are good to compare because there is hardly any overlap in these two indices. Only a handful of stocks have dual listings. The AD Volume Ratio surged above 10 in March and above 9 in mid August. Both surges coincided with significant lows. The AD Volume Ratio also surged above 10 on Tuesday. As with the Nasdaq, it is tough to base a trend reversal on one big day. Follow-through is the key. Let's see the November lows hold AND another impressive surge before considering a trend change. SharpCharts users can click this chart to see the settings and save it to their Favorites.
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AD VOLUME RATIO EXPLAINED ... The AD Volume Ratio equals the volume of advancing stocks divided by the volume of declining stocks. The AD Volume Ratio can be charted by using the indicator section in SharpCharts. First, plot a chart for the Nasdaq ($COMPQ). Under Indicators, choose "Price." Under Parameters, enter "$NAUPV:$NADNV," without the quotes. Under Position, choose "Below." Under Style, choose "Histogram." Now click Update and you will have a chart of the Nasdaq with the AD Volume Ratio in the bottom indicator window. For the NYSE, "$NYUPV:$NYDNV" is the symbol for the AD Volume Ratio.
