Evidence Points to Further Testing of the Lows

• S&P engulfing pattern hints at downside pressure to come
• Guggenheim asset ratio continues to signal money outflow
• EEM give indications of a better short-term performance to come
• BOJ so far fails the inflation test

US Equities short-term

The recent wild swings in the market may look random in nature but so far there has been a certain amount of order to the process. To explain this I need to move away from my longer-term perspective, which remains bearish, to consider the action since the August 24 intraday ”panic” low. That session experienced a lot of the characteristics of an exhaustion day. That’s a day following a sharp decline, the price gaps sharply lower on the opening, but by the end of trading closes above that opening price. Lots of volume also helps as that indicates that substantial liquidation has taken place. “Exhaustion” in this sense means the cessation of liquidation from strongly motivated sellers. Such one day price patterns usually mark the intraday low for several weeks, often longer. So far that theory has taken hold, as prices have traded well above the August 24 low.

The next two bars represent what we call “inside” days. They are ones whose trading range is totally encompassed by the previous session's range. Inside days offer an additional message that the previous balance strongly favoring sellers is now more evenly matched. That’s because neither side is able to push prices higher or lower. The two inside days again add support to the idea that the August 24 low will hold for a while.

Chart 1

Other evidence in this direction comes from Charts 2 and 3. Chart 2 shows that the $VIX reached a very high level that has been consistent with market lows in the past.

Chart 2

Chart 3, for its part, tells us that the number of new net NYSE 52-week highs touched a very oversold level, again consistent with some form of bottom.

Chart 3

Getting back to the daily bar analysis, but now adopting candlesticks, we see that Wednesday’s action represented the second candle in a bearish engulfing pattern (Chart 4). Engulfing formations develop when the range between the open and the close (known as the real body) of the engulfing candle encompass that of its predecessor. If, following a decline, the close on that engulfing candle is higher than the opening, that second candle is bullish and earns a white real body. On the other hand if, following an advance, the close develops below the opening, as was the case on Wednesday, that’s bearish and the real body is colored in black. The reason lies in the fact that the higher opening on the second candle draws in many bullish traders who think prices are moving higher. Short covering may also represent part of the picture. However, at the end of the session disappointment sets in as these traders are sent home with a loss and therefore represent overhead supply. If the price rose because of short covering that potential demand has now been eliminated and the technical position that much weaker. Wednesday’s engulfing candle met all the requirements, except that its downward influence may be tempered by the fact that it developed after a two day advance that itself was part of a trading range. The bottom line is that until Wednesday’s high is bettered, thereby cancelling the engulfment, the risk of lower prices is very real.

If the longer term indicators were signaling a primary bull market I would label such a dip, should it transpire, as a screaming buying opportunity.  However, as I pointed out in this week’s webinar, there are lots of reasons for suspecting that we are at the beginning of a bear market. That’s an important distinction because indicators behave differently in bull and bear markets. Prices are extremely sensitive to oversold conditions when the trend is up but are far more lethargic when the trend is down. My best guess is that the low will hold for a while longer or may be temporarily breached but that the next sustainable down leg will come later. Remember that’s just a guess, no one knows for sure. The best policy unless you are extremely nimble, is to stand aside until the volatility subsides.

Chart 4

Emerging markets to the (short-term) rescue?

Chart 5 shows that the MSCI Emerging Markets ETF (EEM) has been in a declining trend for some time. Now the KST for relative action, in the lower window, has started to go bullish. This holds out the hope that the RS line will be able to build on its recent tentative trend line penetration and that bullish vibes can extend to the price itself. Longer-term this ETF looks pretty sick but there is no reason which these markets cannot enjoy a respite from their individual bear markets.

Chart 5

Guggenheim (Rydex) asset flows.

One indicator that I do not like the look of is featured in Charts 6 and 7. It is the Guggenheim (formerly Rydex) Asset Ratio and you can read about it here. Essentially it measures asset flows between bullish and bearish Guggenheim funds.  Chart 6 shows the longer term history, where you can see that it has been possible to construct trendlines for both the indicator and the S&P. Joint violations have conveniently signaled primary trend reversals. Sometimes, as in 2009, it is not possible to observe such events in which case the indicator offers no signaling capabilities. Recently we saw a joint break to the downside signaling the probability of a primary bear market.

Chart 6

Chart 7 shows the same relationship, but this time for a more limited period using daily data. Again we use joint trend line breaks to indicate when money flows and stock prices are reversing trend. Recently the ratio, like the S&P, broke down from a trading range. The August 24 low for the market average has managed to hold. However, the new low for the ratio continues to underscore the fact that money is being pulled out of the market, which is obviously not a positive sign.

Chart 7

The Yen and Inflation

Some time ago the Bank of Japan began an aggressive program of security purchases with a key objective of overcoming the deflationary pressures that had plagued the country for a couple of decades. Charts 8 and 9 indicate that they have not been very successful so far. Chart 8 for instance, expresses commodity prices in yen. As you can see this yen-adjusted DB Commodity ETF (DBC:$XJY) has recently broken down to a significant new multi-year low.

Chart 8

Gold is usually purchased as an inflation asset. However, Chart 9 shows that yen-denominated gold has recently violated a major up trendline. Since the KST in the bottom window has just gone negative it would seem that gold, when expressed in yen, is also likely to move much lower—hardly a vote of confidence for future yen-denominated inflation!

Chart 9

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.