A RALLY IN THE FACE OF BAD ECONOMIC NEWS IS A SIGN OF AN OVERSOLD MARKET -- MAJOR MARKET INDEXES TEST THEIR 50-DAY AVERAGES

DON'T TRADE OFF ECONOMIC NEWS ... We had a nice example last Friday of the stock market rallying on very bad economic news. Friday's employment report was the worst in more than thirty years. And yet, the stock market rallied after a lower opening. Media watchers were puzzled by the market's "strange" behavior. The media has feasted on a plate of worsening economic news. Here's a question for them. Why do they think the market has lost half of its value in only a year which is one of the fastest drops in history? Isn't it likely that the market was discounting a very bad economy? The S&P 500 tumbled 40% between September and November. Now we're hearing that retail spending was terrible during that time span. Doesn't that explain why the market fell so sharply in the first place? What the media and economists don't understand is that the stock market anticipates fundamental information before it becomes generally known. Once it's known, an oversold market will usually rally on that bad news.

Chart 1

MARKET IS OVERSOLD... I wrote yesterday that the ability of the stock market to bounce in the face of bearish news is a sign of a sold out market. One of our readers asked if that meant that the market was in an oversold condition. The answer is yes for both our weekly and monthly oscillators. The monthly bars in Chart 2 show the 14-month RSI in oversold territory below 30 for the first time in six years. The proximity to its 2002 low has also provided some support. When the market bounces on weak economic news, that's a sign that much of that bad news has already been discounted.

Chart 2

STOCK INDEXES TEST 50-DAY AVERAGE ... I wrote not too long ago that the major market averages appeared headed for a test of their 50-day moving averages. They're now in the process of testing that important resistance barrier. Chart 3 shows the S&P 500 SPDRs backing off today from its 50-day line. One encouraging sign was that today's modest selloff took place on lower volume. Even so, the S&P needs a decisive close over its 50-day line to signal that the recent rebound is more than a short-term bounce. Charts 4 and 5 show the Dow Diamonds and the Power Shares QQQ Trust testing their 50-day averages as well.

Chart 3

Chart 4

Chart 5