DAILY OVERSOLD READINGS COULD SUPPORT REBOUND -- BUT WEEKLY RSI NOT YET OVERSOLD -- NEITHER IS THE % SPX STOCKS BELOW 200-DAY LINE -- VIX INDEX REACHES POTENTIAL RESISTANCE AT 40
VERY OVERSOLD BUT NO REBOUND YET... After this week's stock plunge, it's not surprising to see short-term momentum and sentiment indicators reach very oversold conditions. That doesn't guarantee a short-term bottom; but does increase the technical odds for one. And even if one does occur, that wouldn't guarantee a final bottom. But possibly the beginning of one. An actual bottom would probably require a retesting process (after a rebound) in order to repair the technical and psychological damage done over the past week. Even that possibility doesn't address the bigger question of whether the longest economic expansion and bull market in history is finally peaking. We'll leave that last debate for another day. Let's deal with the first part today. Starting with short-term oversold readings.
The daily bars in Chart 1 show the S&P 500 dropping on Friday to a potential support level at its early October intra-day low at 2855 before recovering some of that lost ground later in the day. The green Fibonacci retracement linesalso show the SPX having lost 50% of its rally from the December 2018 low. Those are logical spots for the SPX to attempt a rebound; and Friday's late buying (in heavier trading) was somewhat encouraging. So is the 14-day RSI line in the upper box which fell to deeply oversold territory near the 11 level. That's its most oversold reading since the end of 2018.
For the deeply oversold reading in the RSI to signal a potential bottom, however, some things need to happen. First of all, the RSI line needs to rise back over 30 to signal the possibility of a short-term bottom. Notice also that the RSI line formed two bottoms near the end of 2018. That's not unusual. In fact, most stock bottoms over the last ten years have required at least two bottoms in the RSI line (and sometimes even more). That because the intial rebound from a bottom usually requires a retest of that bottom. It's usually the second oversold bottom in the RSI that's the more critical. Which suggests that any rebound from the short-term oversold condition would most likely be followed by another retest. In addition, it's usually dangerous to rely exclusively on short-term readings on daily charts. When looking at a potential signal on a daily chart, it's usually a good idea to look at a weekly chart for confirmation.
WEEKLY RSI LINE ISN'T OVERSOLD YET... Chart 2 overlays a 9-week RSI line on weekly S&P 500 price bars over the last six years. The weekly RSI value is shortened to 9 weeks which works better for determining overbought and oversold readings. The main point of the chart is to show that the 9-week RSI is currently at 31, and hasn't yet reached oversold territory (below 30). The last two SPX bottoms in late 2018 and mid-2015/early 2016 saw the weekly RSI line drop below 30. [In fact, every market correction in the last eleven years has pushed the 9-week RSI below 30]. And in both instances shown here, a second dip in the weekly RSI line was needed to complete a bottom (see circles). Which suggests that there's more work needed to be done to call for a bottom based solely on RSI readings.
% S&P 500 STOCKS ABOVE 50-DAY AVERAGE OVERSOLD... The blue line in Chart 3 plots the S&P 500 percent of stocks above their 50-day moving average. Last Saturday's message showed some weakening in that line over the prior week from overbought territory above 80% which hinted at possible weakness ahead. Unfortunately, that warning was correct. This week's chart, however, may carry some better news. The blue line has dropped below 4% this week which puts it well below the oversold line at 20%. Prior drops to that low level over the last ten years have usually coincided with market bottoms. But there's another line that needs to also be considered. While drops below 50-day averages are negative warnings, drops below 200-day lines usually have a bigger impact on market trends.
% S&P 500 STOCKS OVER 200-DAY LINE NOT YET OVERSOLD... The red line in Chart 4 is the S&P percent of stocks above their 200-day moving average. A message from two weeks expressed concerned about the weakening in that line from overbought territory over 80%. Since then, the red line has dropped all the way to nearly 25%. That means that 75% of SPX stocks are below their 200-day lines. As low as that 25% reading is, however, it's not low enough to signal an oversold market. For that to happen, it would have to dip closer to 20% which signaled market bottoms during 2018, 2015-2016, and 2011. Which is another indication that stocks haven't yet reached the type of oversold condition that usually marks major bottoms. A short-term rebound maybe; but not a major bottom.
VIX INDEX REACHES 40... Chart 5 shows the CBOE Volatility (VIX) Index ending the week at 40 which puts it at the highest close since the middle of 2015 (only daily closing prices are shown). Its closing peak from slightly above 40 that year, and subsequent downturn, helped start a bottoming process which took six months to complete. But its current value is higher than its two 2018 peaks which suggests more fear than during both those downturns. The VIX closed as high as 48 during 2011. But its drop back below the 40 level that year signaled a market bottom. What the chart shows is that closes at or above 40 in the VIX don't happen very often and have usually preceded market bottoms. For that to happen, however, the VIX needs to start dropping from that potential resistance level. It reached 49 during Friday's early intra-day trading before closing near the bottom of the day's trading range at 40. That's slightly encouraging. So is the fact that its 14-day RSI reading of 87 is the most overbought in two years. Its weekly RSI reading at 78 is also the highest level in two years; and the second highest since 2008. Bear in mind, however, that all of these indicator readings have been taken during an 11-year bull market. They may have less relevance if the longest bull market in history is ending.
