Oversold Condition Should generate a Short-term US Equity Rally as Part of an Overall Topping Process

• Bottom Fisher indicator may be close to an upside reversal.
• If the rally develops watch the value Line Arithmetic for an indication of its resilience.
• Gold shares may be about to break to the upside.

(Click here for a video version of this article.)

US Equities

Last week the NYSE Composite fell to support in the form of its bull market trendline, which is currently around 10,500. You may recall that a breach of a Special K trendline, with a duration greater than a year, more often than not signals a primary trend reversal. Last week the red bull market and the more conservative dashed blue trendline were decisively violated.

The indicator also fell slightly below its MA. This is not yet a decisive break but will likely become one. Since the  trendline for the price has so far held, as it has on multiple occasions during the course of the bull market, there is a pretty good chance that we might see a short-term rally develop. I’ll address that point later.  However, at this juncture I think it’s important to bear in mind that the Special K trendline break most probably means that the market is in a topping out mode. Markets rarely reverse on a dime and that means that at least a test of the June high is in order. The Special K trendline break argues against a new high but certainly does not guarantee that a higher high down the road will not be seen.

Chart 1

Last week I introduced the Pring Bottom Fisher, which you can read about here. If goes bullish for the market when it reverses direction from an oversold reading below the green “bottom fishing” line. Right now it’s slightly below the fishing line but is still declining. Consequently, it has not yet given us the all clear. As you can see, in a bull market it usually generates a nice rally. That’s because these are pro trend signals. At the top of bull markets or during a bear market the signals still seem to work but their strength is generally  well below those triggered in a bull market. Look at the signals generated at the end of the 2007-2009 bear market and that around the  2011 peak. None of them amount to that much of an advance.

Chart 2

Chart 3 features my Dow Diffusion Indicator, this one measures the percentage of the Dow stocks that are in a positive trend and triggers a buy signal when it falls to its oversold zone and reverses. Those and other below 50% reversals have been flagged by the green arrows. This series is not yet rising but it seems to me that if the Bottom Fisher were to reverse that would be sufficient to give us a bullish Dow Diffusion indicator signal as well.

Chart 3

Finally in the equity area the Value Line Arithmetic has been one of the weakest areas. As a result the Index recently violated a key up trendline. Now that its KST is oversold and starting to stabilize we should see a rally develop. The key test lies at the intersection of the two red lines at 4550.  That’s because the violation of the up trendline indicated a loss of upside momentum. Therefore a rally above the line would mean that that upside momentum had been regained leading to probable new highs. I think the odds of that happening are quite low but if one of the weakest market sectors can regain upside momentum pretty well anything else ought to as well.

Chart 4

US Credit Markets

The Barclays 7-10-year bond trust, the IEF, continues to trade above the key intermediate up trendline. However, the stochastic remains in an overbought and declining state. That suggests that a test of the line is likely. I am still looking at the previous minor low as my benchmark since a break below it would also result in a decisive trendline break. Until then I am assuming the trend is positive.

Chart 5

US Dollar Index

Chart 6 tells us that the US Dollar ETF, the UUP, recently broke to the upside. The KST is a bit overextended but still rising, which means that resistance at the blue line at $21.85 may cause some temporary problems in the form of a 2-4-week correction, all within the recent trading range.

Chart 6

Precious Metals

The Gold Share ETF, the GDX, has reached a very critical point in its technical development because it is right at the breakout point of  a potentially very important base. You can see that the bullish percentage of gold stocks has registered a lower peak each time the price has touched the breakout trendline. However, this negative is being offset by a breakout  above the green down trendline.  This line goes all the way back to 2012, so it’s an important one. Unfortunately the KST is still bearish, but on Wednesday it stabilized, which could be a sign that it’s about to reverse. Remember the long-term KST, which reflects the primary trend, is already bullish. The key will be to see whether it can rally and hold above the all-important $27.50 level.

Chart 7

One clue that it might comes from the ratio between the shares and bond prices, a key inflation/deflation relationship. It remains below its AB bear market trendline but has broken out  from an important base flagged by the green dashed line. This breakout is  being supported by a positive long-term and rising intermediate KST. The short-term series is still declining...

Chart 8

...but when we consider a more sensitive momentum indicator such as the MACD in Chart 9 we can see that it has already gone bullish. My bet is that we see a more decisive breakout in the GDX/TLT relationship as well as one for the GDX itself.

Chart 9

We see a similar setup for metal itself in the form of the Gold Trust, the GLD. The overall scene is set by the positive trend of the long-term KST and the potential base by the price itself. The short-term KST has worked off its recent overbought condition and has started to stabilize.

Chart 10

It looks to me as if it will soon go bullish because the 24/10/10 stochastic in Chart 11 has gone bullish. Recent buy signals have been followed by the kind of rally that would be sufficient to trigger s short-term KST buy signal.

Chart 11

Commodities

The Dow Jones UBS Commodity ETN, except for a brief period during June, has been caught in a downward trend channel. I have, for the most part, taken a bullish stance, which has clearly been wrong. Right now both momentum series are oversold and moving sideways. If we see a break above the upper trendline at say $37.25 that would suggests a short-term rally.

On the other hand, a break below support at the red trendline would be quite serious.

Chart 12

That can best be appreciated from Chart 13, which features the monthly action of the CRB Composite. The Index has been in a trading range for the last 3-4-years but its long-term KST has triggered a buy signal, hence my misplaced bullishness over the last few weeks. The KST has now gone flat and that could be a prelude to a reversal to the downside.  Caution on that one, because the last time it went flat in 2010 a sharp rally followed as the KST subsequently reverted to the upside.

Chart 13

Good luck and good charting!

Martin Pring