STOCKS REACH MOST OVERSOLD LEVEL IN TWO YEARS -- THAT DOESN'T NECESSARILY SIGNAL A BOTTOM -- BUT IT MAY LEAD TO A SHORT-TERM RELIEF RALLY -- USE FIBONACCI LINES TO FIND OVERHEAD RESISTANCE
S&P OVERSHOOTS DOWNSIDE TARGET... Last Thursday's message offered a downside target in the S&P 500 to 1150. That level was based on a measurement from the "head and shoulders" top that was completed last week. The 1150 was also a 62% retracement of the rally from last summer. The daily bars in Chart 1 shows the S&P 500 overshooting both downside targets in yesterday's selling rout. In addition, the market has reached the most oversold level in years. The daily RSI line at 18 is at the lowest level since the spring of 2009. The weekly RSI (not shown) has also reached oversold territory at 30 for the first time in two years. The SPX is also testing a potential support level along its April 2010 peak at 1125. None of these factors suggest that a final bottom has been seen. In fact, I strongly suspect that the SPX may eventually drop as far as its summer 2010 low. They do suggest, however, that the selloff has been overdone and the market due for a relief bounce.
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Chart 1
MARKET MOST OVERSOLD IN TWO YEARS... The two measures below show how oversold the market has become. Chart 2 shows the % of NYSE stocks trading below their 50-day averages (NYA50r). As of yesterday, that measure had fallen below 10% for the first time since the spring of 2009. While that signals that market sentiment has gotten too bearish, it doesn't necessarily signal a final bottom. During 2008, the indicator fell below 10% during October which led to a short-term rally. The final market bottom, however, didn't occur for another five months when the indicator dipped below 10% for the second time. Chart 3 shows the % NYSE stocks below their 200-day averages also falling below 10% for the first time since the spring of 2009. It also hit that level in late 2002. In both instances, however, the first drop below 10% didn't signal a final bottom. In fact, both previous dips below 10% took place during October 2002 and 2008 and, in both instances, the market didn't bottom until the following March (2003 and 2009). So there's good and bad news here. The good news is that both indicators have dropped to levels that suggest a very oversold market. The bad news is that the market may still be months away from hitting a final bottom. It's also worth noting that the most dangerous time of the year -- September and October -- still lie ahead.
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Chart 2
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Chart 3
FIBONACCI RESISTANCE POINTS... We've been using Fibonacci retracement lines to look for potential support levels. If the market does rebound, we can use those same lines to locate potential overhead resistance. The horizontal lines in Chart 4 measure the decline from the late July peak (near 1350) to yesterday's low in the SPX. That was a drop of 230 points. The lower two lines show that a 38% to 50% retracement of that decline would carry to 1200-1230 region (with the lower line being more likely). If an oversold bounce does materialize over the next few days, keep those overhead resistance lines in mind. Another level worth watching is the 50 line on the 14-day RSI. During downtrends, the RSI usually meets resistance at its 50 line. Technical factors, therefore, suggest that the best we may be able to hope for over the short run is a relief rally followed by more selling. Seasonal factors also suggest a downside bias into the autumn months.
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Chart 4
OFF TO SEATTLE... I'm heading to Seattle this afternoon to participate in the first Stockcharts.com Chart Conference (Chartcon). It should be very educational and enjoyable. I can't think of a better time to spend a few days studying market charts. I've been struck over the last week by the complete absence of chart analysis on the TV business networks during the current crisis. That's their loss. We'll make up for that omission in Seattle. Looking forward to meeting many of you.
