Market Explodes On Bad News. Has The Year-End Rally Begun?

• Two bar reversal says the market is going higher near-term
• Credit spreads at key juncture point
• Oil showing tentative sign of a short-term reversal but confirmation is required

They say that a market that does not decline on bad news is usually ready to reverse to the upside. Over the weekend, the tragic events in Paris and their wider negative implications certainly gave the bears an excuse to sell. Prices rose instead of dropping. Many measures of short-term momentum are still overbought.  We will get to that later. However, Monday’s price action was pretty impressive as many indexes experienced the second day of a bullish two-bar reversal. These are only short-term patterns, which are expected to have an effect for no more than five to ten days. However, in that period of time, it is likely that many short-term oscillators could find enough strength to reverse to the upside. Remember the market has yet to experience the full effects of the bullish year-end seasonal pattern, and it is also in the early phase of the bullish November-April holding period. Also, 2015 ends in a “5” digit and “5” years have not been on the losing side since 1875.  That’s not to say that the market can’t go down or that the two-bar reversal will fail. That’s always possible because there are no certainties in technical analysis, only probabilities. For example, the two-bar reversal would fail in the event that prices move decisively below the lower of Friday or Monday’s low and that would turn the short-term picture into a bearish one again.

Chart 1 features the S&P Composite ($SPX) together with its 8/16 PPO. The two-bar reversal is contained within the green ellipse, where you can see that Friday’s action opened near the high and closed near the low. Monday saw a complete reversal of this behavior, indicating that within two days trading, sellers had given control back to the buyers. Note that anyone going short in these two days and who has not yet covered is almost certainly facing a loss. Those outstanding short positions represent buying power that should propel the market higher for a few sessions. Note also that the correction took the price right back to the upper end of the double bottom formation that developed in the August/October period, a great support place from which to rally. The PPO is currently declining but has begun to flatten. If the two-bar reversal works that should result in a PPO reversal.

Chart 1

Chart 2 also brings out some bullish points, but this time from the candles. I have labeled the Friday/Monday phenomenon as a piercing white line/engulfing formation since Monday’s opening was pretty close to Friday’s low and the Monday session closed the price well up from the half-way point of Friday’s real body. In fact, it more than engulfed the real body as it closed above Friday’s open. I may be pushing the white line interpretation a bit, but the point is that this is bullish action it really does not matter what you call it. One slightly negative observation comes from the fact that Monday’s bullish candle is a tad narrower than Friday’s. Remember, this is a candle volume chart, where the width denotes the level of activity, so the wider the candle, the greater the volume. That means that there was higher volume on the downside (Friday) than Monday’s up-day.

Chart 2

Chart 3 shows the NYSE Composite ($NYA) together with its 14-day money flow index (MFI). It has now reached the oversold level but needs to reverse to the upside in order to earn a buy signal. Previous ones have been flagged by the green arrows. The solid ones indicate signals that worked and the dashed ones failures. If Monday’s two-bar reversal works, that should provide sufficient strength to enable the MFI to turn up, thereby adding more evidence favoring a very near-term rally.

Chart 3

The action of these indicators is encouraging, but this is only of short-term significance. It remains to be seen how some of the slower moving oscillators behave. For example, Chart 4 tells us that by some measures the S&P is still overbought as the KST is pretty elevated and has only just begun a downward trajectory.

Chart 4

Also, Chart 5 points up that the cumulative line calculated from the net new high/low percentage numbers ($NYHL), having experienced a small rally, has now turned south again. Note that the KST for this breadth measurement is still very overstretched on the upside, suggesting that further downside lies ahead.

My best guess at this point, and that’s all it is, a guess, is that the S&P Composite ($SPX) will make an attempt at its November high. During that period, I want to take a closer look at the volume and breadth data to see whether it’s more of a reflex action or if it has the strength to push on to new 2015 highs. On the other hand, all this means nothing if prices slip below their Friday or Monday lows.

Chart 5

Credit Spreads

One of the other things worth monitoring is the spread between treasuries and junk bonds in the form of the iBoxx High Yield and the Barclays 7-10-year Trust ETF’s, the HYG to the IEF. A falling spread is bearish for stocks and commodities because it shows that bond investors are favoring quality over junk and vice versa.

On a long-term basis, the ratio is very oversold and this chart shows that there is a possibility that it may be forming a reverse head and shoulders pattern. That would happen with a break above the green trend line at 80.5. The situation is a bit complicated right now because the ratio itself, along with the HYG, experienced a strong bullish piercing white line on Monday. Unfortunately, the KST has just triggered a sell signal, which means that any rally by the ratio will run into a bit of a downside momentum head wind.

Chart 6

Chart 7 shows why this is so critical, as the ratio is struggling to remain above the red horizontal trendline. If it drops much more, then a more protracted decline would be expected. That in itself would indicate a loss of confidence and a probable violation of the blue horizontal potential head and shoulders neckline on the S&P Composite in the upper window of the chart.

Chart 7

Oil and Energy Equities

I’ll be showing some long-term charts of the CRB Composite ($CRB) and the oil price ($WTIC) at my webinar tomorrow as both have fallen to mega support levels. After Monday’s trading, the short-term picture has started to come to life, at least for the oil price.

The iPath Oil ETF (OIL), recently broke down from a head and shoulders consolidation pattern. That formation is still effective, but Monday’s bullish outside bar holds out the hope that the pattern will not work. In order for this scenario to turn into reality, the price has to first move back above the neckline at $8. But more importantly, the price action needs to violate the green down trendline with a decisive break, say to the $8.60-7-0 level. The KST is still declining but at a relatively neutral reading could reverse quite easily. It certainly would in the event of a green trendline violation.

Chart 8

Our final chart features the Spider Energy ETF, the XLE together with its RS line. The price itself recently confirmed a false breakout above the green trend line by subsequently penetrating the red uptrend line. That bearish scenario still holds, however, as the bullish turn-around price bar that was formed on Monday hints at the possibility that an attempt at the early November breakout high may be about to take place. Right now the KST action is bearish, so my best guess is that it will not succeed, However, if it does and the oil price itself also violates its green down trendline in the previous chart, we could see a spirited and broadly based energy rally. Stay tuned!

Chart 9

The webinar will be on Tuesday, November 17, 2015. Click here to register. Martin Pring's Market Roundup Live 20151117.

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.