Bearish One Day Reversal and KST Argue for a Short-term Correction

• Several market averages experience bearish outside days.
• NASDAQ Composite forms bearish Pinocchio bar
• Brokers leading the market lower
• Further dollar weakness anticipated
• Gold just below key resistance
• Commodities break out from a nice base

US Equities

I have been saying for several weeks that the market is overextended but that higher prices are likely. That statement may still be true but for the moment some form of correction is likely. This view is based on two factors.

First Tuesday saw several market averages form bearish outside days. Second, that the outside day formed when short-term momentum indicators such as the KST have or look about to trigger short-term sell signals. Chart 1 features the S&P and the red shading flags the outside day. An outside day is one in which its trading range totally encompasses one or more of its predecessors. The wider the bar and the sharper the rally preceding it the stronger the signal. This was a wide bar and follows  a reasonably strong rally, so there are lots of traders who will probably wish to take profits.  Note that the shaded  bar on the left was also an outside bar and had the normal expected effect lasting from between five and ten days.

Chart 1

However, as Chart 2 shows, this comes  at a time when the KST has just gone bearish.  These sell signals usually last between four and six weeks. No guarantees though. It seems likely that the $192.50 area flagged by the extended breakout trendline will now be challenged. If it holds, it’s possible we could go on to register new highs, but if it gives way, a more protracted sell-off would be likely.

Chart 2

Chart 3 shows that problems also extend to the NASDAQ, where the NASDAQ Composite experienced a Pinocchio bar on Tuesday. These one day patterns develop when a price rallies through resistance on an intraday basis but the open and the close do not. Pinocchios are exhaustion phenomena. In this instance resistance is evidenced by the horizontal trendline connecting with the previous high. It’s a kind of a whipsaw move  that traps buyers who bought above the resistance and who will now be putting pressure on prices. In this case the KST is rolling over but not quite bearish. The negative effect of the Pinocchio will likely result in an actual sell signal fairly soon.

Chart 3

Chart 4 takes this a bit further because it points out that even though the NASDAQ made a new high on Tuesday the number of NASDAQ stocks in bullish trends seriously lagged. That tells us that there was not a broad participation  when the NASDAQ was registering a new bull market high and that's not encouraging.

Chart 4

One area I pay close attention to is the broker sector. The S&P discounts the economy but brokers have a habit of leading the market itself both on the upside and the downside. That’s because they make more profits from traders and IPOs in a bull market and not so much in bearish environments. In this respect after a large decline I like to see the brokers fail to confirm new lows in the market itself. Unfortunately the opposite is the case right now as the brokers refused to confirm the latest S&P high. Note that the relative strength line in the bottom panel of Chart 5 is almost at a post December low, not the kind of thing we like to see just after a new bull market high.

Chart 5

US Credit Markets

If the stock  market sells off that could give a new lease on life to the bond market and it certainly needs it. Chart 6 shows that the price of the 30-year bond has fallen to a key red support trendline. That’s occurring at a time when two of the ROC indicators have experienced a marginal breakdown. Should all three and the trendline for the price give way that would strongly suggest that the intermediate rally is over.

Chart 6

Note also that the KST for the Barclays 20-year Trust, the TLT has started to flatten and looks like it may reverse to the upside. That would avoid the completion of a small potential head and shoulders with a break just below $111. On the other hand, the extended dashed up trendline represents resistance which could well place a cap on prices, likely resulting in a trading range environment.

Chart 7

US Dollar Index

The US Dollar Index is still experiencing negative short-term momentum as we can see from the declining KST. Right now that suggests a test of the 79 area. However, should the dollar contain its expected decline and then move back above the green line at 80.80  that would be the signal for a rally of intermediate importance.

Chart 8

Precious Metals

The KST is bullish and has now rallied back above the dashed red trendline. This  quick momentum recovery is a sign of technical strength. The price of the GLD  has reached very important resistance in the form of its bear market trendline. The unusually sharp recent run up hints at the likelihood of some digestion of recent gains before a successful assault can be made on both that line and the green dashed one around $131. A move above $131 would, in my opinion, signal a primary bull market and the low reading in the KST suggests that that could well happen.

Chart 9

Commodities

The Powershares DB Commodity ETF, has just completed a reverse head and shoulders. That, along with the recent buy signal in the KST suggests that prices are headed significantly higher. If that does prove to be the case that would also suggest that downside pressure on bond prices.

Chart 10

Good luck and good charting!
Martin Pring