BREADTH INDICATORS REFLECT BROAD SELLING DOWNSIDE VOLUME PICKS UP PACE A LOOK AT THE PRIOR BEAR MARKET HOW THE CURRENT RALLY STACKS UP LOOKING AHEAD SEVEN MONTHS

NASDAQ DECLINES ON HIGH VOLUME ... Breadth indicators are one of my first ports of call after a big market move. With the major indices moving sharply lower on Wednesday, the breadth statistics can tell us if this decline was broad-based or relatively narrow. Charts 1 and 2 show Volume, Net Advances, Net Advancing Volume and Net New Highs for the Nasdaq and the NY Composite. Net Advances equals advancing stocks less declining stocks. Net Advancing Volume equals volume of advancing stocks less volume of declining stocks. Net New Highs equal new 52-week highs less new 52-week lows. Starting with the Nasdaq, Starting with the Nasdaq, let's take these one at a time for each index.

Volume surged last Thursday as the Nasdaq forged an outside reversal. In addition, volume remained above average as the Nasdaq declined further over the last three days. This is a bearish combination. Participation in Wednesday's decline was broad as Net Advances moved below 1800 (blue line). Also notice that this is the lowest level since early March. Wednesday's decline was not your average garden variety. Turning to Net Advancing Volume, we can see two negative extremes in the last two weeks (red arrows). Net Advancing Volume reflects the performance of large-caps because large-caps dominate the most active list (volume leaders). Finally, Net New Highs moved back to the zero line in late March, but never managed to move significantly into positive territory.

Chart 1

NYSE NET ADVANCES DIP SHARPLY... Turning to the NYSE, we can see a similar breadth picture. First, the index forged an intraday reversal last Thursday with high volume. Although volume was average on Monday's decline, it surged again on Wednesday's decline. As with the Nasdaq, the NY Composite features a high volume reversal and further weakness on above average volume. This shows a marked increase in selling pressure. Furthermore, Net Advances dipped below 2000 for the first time since mid April. Selling pressure was broad. Net Advancing Volume held up better by remaining above its April low. Even though the NY Composite was up slightly on Tuesday (green volume bar), Net Advances and Net Advancing Volume were still decidedly negative. Net New Highs have been flat since late March and have not managed to expand into positive territory.

Chart 2

THE PRIOR BEAR MARKET... We can look at the prior bear markets to get an idea of how current or future bear markets may pan out. Chart 3 shows the S&P 500 from January 2000 until December 2002, which captures the prior bear market. Except for a few days in the first quarter of 2002, the 200-day moving average largely held throughout the decline. There were three short, and very sharp, rallies during this bear market (yellow areas). Each rally lasted 4-12 weeks and the S&P 500 gained around 20% each time. Chart 4 shows these prior bear market rallies with retracements. The first rally retraced 50% of the prior decline, the second rally retraced 60% and the third rally retraced 44%. In a nut shell, these bear market rallies retraced 40-60% with a sharp advance (20%) in a short timeframe (4-11 weeks).

Chart 3

Chart 4

THE CURRENT RALLY... Looking at the current S&P 500 chart (5), we can see that the index tested its falling 200-day moving average for the second time since the bear market began. In addition, the current rally is very sharp (~35%). From the March low to the May high, the current rally is around nine weeks old. The gains are much more than prior bear market rallies. Perhaps it is different. In addition, the advance came very close to the January high, which marked the peak of the prior bear market rally. Looking at the prior bear market, I noticed that the impressive Oct-Nov 2002 surge also fell just short of the August 2002 high. Like the Mar-May 2009 surge, the Oct-Nov 2002 surge retraced almost the entire prior decline (green arrows on charts 3 and 4).

Chart 5

A W BOTTOM?... So what happened after the impressive surge in Oct-Nov 2002? Chart 6 shows a large "W" bottom forming over a 9-10 month period (from July 2002 until April 2003). That seems like an eternity in 2009 time! This consolidation formed a large base from which the bull market was launched in early 2003. Also notice that five months elapsed from the October low to the March low (retest) . Should a similar scenario unfold, we would see the S&P 500 decline into August and then mount a strong advance to form a large "W" type bottom (Chart 7). This scenario also fits with John Murphy's suggestion that an inverse head-and-shoulders pattern could be forming. Alternatively, the red line shows a scenario where stocks meander for a few months, decline into September-October and then mount a strong advance.

Chart 6

Chart 7