S&P 500 MAINTAINS ITS LONG-TERM UPTREND -- CONSUMER DISCRETIONARY SECTOR ETFS TESTS KEY LEVEL -- MACY'S, NORDSTROM AND TJX LEAD RETAILERS HIGHER -- WHEN IS OVERSOLD REALLY OVERSOLD? -- USING PPO AND RSI FOR TO DEFINE OVERSOLD
S&P 500 MAINTAINS ITS LONG-TERM UPTREND... Link for today's video. Even though the S&P Small-Cap 600 and S&P MidCap 400 are underperforming and have stalled for several months, the S&P 500 remains in a clear uptrend and over 50 points above key support. Will the S&P 500 ultimately pull small and mid-caps higher? Or, will weakness in small-caps and mid-caps ultimately drag the S&P 500 lower. Consider this. The total market cap for the S&P 500 exceeds $18 trillion, the total market cap for the S&P MidCap 400 is around $1.6 trillion and the total market cap for the S&P Small-Cap 600 is less than a trillion dollar ($689 billion). I realize that small-caps and mid-caps are the proverbial canaries in the economic coalmine, but they make up a very small portion of the "stock market" as a whole. A 4% decline in the S&P 500 would knock off some $700 billion worth of market cap in the index. This is the equivalent of the entire market cap of the S&P Small-Cap 600. So, while relative weakness in mid-caps and small-caps is a concern, a full-blown bear market is not going to happen unless the S&P 500 breaks down. Chart 1 shows the S&P 500 hitting a new high three weeks ago and pulling back with another garden-variety decline the last two weeks. Chart 2 shows the S&P MidCap 400 in a consolidation since June testing support in the 1350-1360 area. Chart 3 shows the S&P Small-Cap 600 in a consolidation since December and testing its 2014 lows.
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Chart 1
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Chart 2
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Chart 3
CONSUMER DISCRETIONARY SECTOR ETFS TESTS KEY LEVEL... The Consumer Discretionary SPDR (XLY) and the Equal-Weight Consumer Discretionary ETF (RCD) are both bouncing off important support levels to keep the long-term uptrends alive. As the name suggests, the consumer discretionary sector is the most economically sensitive sector because it is driving by discretionary spending. Retailers, restaurants, automakers and other consumer oriented stocks feature in this sector. Chart 4 shows XLY nearing the early August low with a spike to 65 on Thursday. This spike produced a hammer as the ETF closed near the high of the day. A hammer is a bullish candlestick pattern that requires confirmation, which is happening today as the ETF gapped higher. The indicator window shows Net New Highs remaining in negative territory and near -5%. This is the bearish threshold and an expansion of new lows could have long-term consequences. Chart 5 shows RCD getting a bounce off support in the 78-79 area. The indicator window shows the consumer discretionary AD Line hitting support.
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Chart 4
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Chart 5
MACY'S, NORDSTROM AND TJX LEAD RETAILERS HIGHER... The Retail SPDR (XRT) is leading the market for the second day running with a 1+ percent surge. Chart 6 shows XRT hitting the trend line support zone in the 84-85 area and forming a piercing pattern on Wednesday-Thursday. This pattern forms with a long black candlestick and a long white candlestick. The open of the white (hollow) candlestick is below the close of the black (filled) candlestick and the close of the white candlestick is above the midpoint of the black candlestick body (open-close range). The white candlestick basically pierced the black candlestick with a strong move. Today's follow thru confirms the pattern and keeps the bigger uptrend alive. Notice the higher lows since April and the 52-week high in September. The indicator window shows XRT relative to SPY. XRT remains a laggard overall, but the price relative flattened over the last few months. A break above the red resistance zone would signal a return to outperformance.
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Chart 6
Chart 7 shows Macy's (M) finding support at the longest volume-by-price bar. This indicator matches volume and price to show areas that may mark support or resistance. Notice how the stock surged to a new high in August and then fell back to this support zone with a falling wedge. A move above 60 would break wedge resistance and reverse the five week slide. Chart 8 shows Nordstrom (JWN) forming a bullish engulfing on Thursday and breaking out on Friday. Chart 9 shows TJX Companies (TJX) holding support at the third longest volume-by-price bar and breaking out with a gap above 60.
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Chart 7
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Chart 8
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Chart 9
WHEN IS OVERSOLD REALLY OVERSOLD?... First and foremost, it is important to remember that oversold is a condition, not really a signal. In other words, oversold simply means prices have fallen sharply in a short period of time. Furthermore, oversold conditions can persist and prices can drop even further. Buying in oversold conditions is like catching a falling knife. It is, therefore, helpful to have some sort of bullish trigger to signal that prices have actually reversed.
The Russell 2000 gives us a timely example because the index fell over 8% in less than five weeks. Frankly, we do not need an indicator to tell us that the index was oversold. Indicators are helpful because they quantify conditions and give us a reference point. Note, however, that indicators vary in sensitivity and this causes some to become oversold more often than others. The next four charts will examine momentum oscillators and the oversold conditions of the last few weeks.
Chart 10 shows the Commodity Channel Index (CCI), which is considered oversold below -100. The challenge here is that the indicator dips below -100 quite frequently. Notice how it dipped below -100 at least five times from late March to late May. This is a classic case of becoming oversold and remaining oversold. Instead of -100, I would use -200 to define oversold conditions and then wait for some sort of upside breakout to suggest that momentum has turned up again. Chart 11 shows the Stochastic Oscillator dipping below 20 rather frequently. This is clearly a short-term indicator that is best suited for nimble traders.
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Chart 10
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Chart 11
USING PPO AND RSI FOR TO DEFINE OVERSOLD ... The next two charts show indicators that are more oriented towards the medium-term. Chart 12 shows the Percentage Price Oscillator (PPO), which measures the percentage difference between the 12-period EMA and the 26-period EMA. The green highlight shows the indicator becoming oversold below -1% in February, April-May, August and now. Notice how the indicator became oversold several times from mid April to mid May. Again, this is a case of becoming oversold and remaining oversold.
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Chart 12
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Chart 13
Chart 13 shows 14-period RSI moving below 30 for the first time since November 2012. This is clearly the least sensitive of the four indicators. Chartists might consider decreasing the parameters from 14-period to 10-period or raising the oversold threshold to 35. The green arrows show dips below 35.
FROM OVERSOLD CONDITION TO BULLISH SIGNAL... Determining oversold conditions is the easy part. The hard part is determining when oversold conditions are ending and the downtrend is reversing. I think the less sensitive indicators (PPO and RSI) are best suited for identifying oversold conditions. It is a personal preference and one size does not fit all. The more sensitive indicators (CCI and Stochastics) are better suited to signal an upturn (after oversold conditions are present). For example, after oversold conditions are present using the PPO or RSI, a CCI surge above zero or a Stochastic surge above 50 would signal an upturn.
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Chart 14
My personal favorite is to use StochRSI for triggers and look for a surge to +1. Chart 14 shows 14-day StochRSI surging to 1 in early February, twice in May and once in early August. Chartists can also watch the price chart and the candlesticks. The February hammer and reversal show a quick reversal, while the yellow area shows a five week bottoming process. There were at least three intraday reversals from mid April to early May, but the index did not fully reverse until the late May surge. Notice how a piercing pattern and a hammer formed within six days of each other. Looking early October, the index formed a piercing pattern in the support zone and follow through with a close above 1110 would be quite positive. Be careful chasing because there is sometimes a subsequent pullback and test of the recent low.
ECONOMY AND LABOR MARKET REMAIN STRONG ENOUGH... It was a big week for economic reporting and the reports were mostly positive. The ISM Manufacturing and Services Indexes fell from relatively high levels, but remain well above 50 and favors economic expansion. Motor Vehicle Sales fell back from their torrid August pace and remain near 16.4 million annualized, which is just fine. The ADP employment growth exceeded 200,000 for the six straight month and this bodes well for the job market. Non-farm payrolls were also strong and the month average for 2014 is 226,000.
Chart 15
QUOTE OF THE WEEK... The following paraphrase comes from an interview with Jeffrey Saut of Raymond James. When asked about the Fed-driven market, Mr. Saut replied:
"The markets don't care about the absolutes of good or bad. All the equity markets care about is whether things are getting better or worse. And things are getting better."
