USING RSI TO TIME A BOUNCE IN THE S&P 500 -- KEY LEVELS FOR SMALL AND MID-CAP ETFS -- AUGUST SEASONAL PATTERNS ARE NEGATIVE FOR STOCKS -- SEASONAL PATTERNS DO FAVOR A STOCK ALTERNATIVE THOUGH
USING RSI TO TIME A BOUNCE IN THE S&P 500... Link for today's video. The S&P 500 finally came under selling pressure to join small-caps and mid-caps with a pullback. The S&P 500 was down 2% on Thursday, which was the sharpest one-day decline since April 10th. It is still just one day and does not make a trend yet. Also keep in mind that the index hit a 52-week high on July 24th and is still within four percent of that high.
Chart 1 shows the index with the 5% zigzag indicator since January 2012. There have been only four declines greater than 5% in over two years. Two occurred in 2012, one in 2013 and one in 2014. Should the index experience another garden-variety decline, say around 7%, we could then see a correction back to the 1850 area. Based on the March-April-May consolidation, there is also a big support zone extending up to the 1890 area. This jibes with the 1890-1900 support zone that Greg put forth in Thursday's Market Message.
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Chart 1
The indicator window shows 10 period RSI moving below 30 for the first time since early February. If the past offers any clues on the futures, RSI may need time to stabilize around 30 before we see a meaningful bounce in the index. A move below 30 signals a short-term oversold condition. As we know, momentum oscillators can become oversold and remain oversold when trends extend. Looking back at the prior pullbacks, I noticed that RSI tends to do a double dip and takes 3-4 weeks to bottom (green shading). This means we could be in for another few weeks of corrective price action. As far as double-dip RSI is concerned, the correction ends after RSI dips to 30 twice and then breaks back above 50.
KEY LEVELS FOR SMALL AND MID-CAP ETFS... Small-caps and mid-caps led the way lower in July, and remain in short-term downtrends. These two need to turn around before the bull market can find another gear. Chart 2 shows the S&P SmallCap iShares (IJR) falling some 5% in July and exceeding its 62% retracement (again). The July decline is relatively steep so I am using the Raff Regression Channel to define the downtrend. The middle line is a linear regression. The outer lines are then set equidistant from the furthest high or low of the move. The upper trend line and late July high combine to mark a resistance zone in the 109-110 area. A close above this level would break the channel and reverse the short-term downtrend. The indicator window shows the S&P SmallCap AD Line ($SMLADP) falling sharply the last five weeks.
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Chart 2
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Chart 3
Chart 3 shows the S&P MidCap SPDR (MDY) near a support zone in the 247.5 area. Support here stems from broken resistance and the 62% retracement. In contrast to IJR above, MDY held its 62% retracement in April and then formed a higher low in May. Notice that MDY showed relative strength in May because IJR moved below its mid April low. A falling flag or channel defines the immediate downtrend, which is still considered a correction within a bigger uptrend. The upper trend line marks first resistance and the late July highs mark key resistance. A breakout here is needed to reverse the immediate downtrend in MDY.
AUGUST SEASONAL PATTERNS ARE NEGATIVE FOR STOCKS... Even though I do not see a major top developing in the stock market, relative weakness in small and mid-caps plus a negative seasonal pattern could make August another rough month. This means IJR and MDY could test their May lows and $SPX could test the 1850-1900 zone. I showed seasonal charts for the S&P 500 and the S&P 500 Volatility Index ($VIX) in the Market Message on July 8th. Over the past 20 years, the S&P 500 advanced just 45% of the time in July, which was the lowest percentage of the twelve months. In contrast, the VIX was up 80% of the time in July. The VIX added another notch to bullish seasonality with a big gain in July. Chart 4 shows the seasonal tendency for the S&P 500 over the last twenty years. The index rose just 53% of the time in August and the average gain was actually a loss (-1.2%). Even though the index advanced more often than it declined, the percentage gains were smaller than the percentage losses. This makes August one of the weakest months of the year for the S&P 500.
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Chart 4
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Chart 5
Chart 5 shows the six year seasonal pattern for the S&P 500. Note that data for the months from January to July is based on six years (six Januarys, six Februarys etc...). Data for August and beyond is based on five years of data because these months have yet to complete. Even though five to six years is a relatively short timeframe, it covers the current bull market, which began in March 2009. During the current bull run, the S&P 500 was up just 40% of the time in August and the average decline was 2.5%. This means the index was down 60% of the time and August has been the weakest link of the bull market. Today's video features a live demo and tutorial on using our Seasonality Charts.
SEASONAL PATTERNS DO FAVOR A STOCK ALTERNATIVE THOUGH... Bonds are the classic alternative to stocks. If the S&P 500 is going to correct, even just 5 to 10 percent, this would likely benefit bonds because money rotates to safer assets (risk off). Chart 6 shows the seasonal tendency for the Dreyfus Long-term Treasury Fund (DRGBX). I am using this as a bond proxy because there is twenty years of data available. August stands out because the fund was up 84% of the time in August and the average monthly gain was 2.1%. This is by far the strongest month of the twelve. Bullish seasonality continues into September and then tails off in October, which is when stock market seasonality turns bullish again.
