Bottoms Up?

• Is the market forming a double bottom?
• Short-term indicators suggest the bottoming process is nearly complete

Sometimes a technical event or characteristic becomes very popular very quickly as a lot of people write and blog about them.  Usually, the expectations based on those forecasts are not met. For example, every so often, warnings of a Hindenburg Omen circulate, but nothing bad ever seems to happen despite the hype.

The latest popular scenario doing the rounds is the potential for an imminent Dow Theory Sell signal. To be fair, proponents point out that it hasn’t happened yet. I have two takeaways. First Dow Theory sell signals develop when both the Industrials and Transports experience a series of declining intermediate peaks and troughs. Analysts calling for a possible Dow Theory sell signal are classifying the February recovery as an intermediate rally. To qualify, using daily closing prices, it should exceed a 33% retracement of the previous decline (January 26-February 8) At better than 60%, it certainly does. However, an intermediate rally should also last at least several weeks, and with a duration of 11-days, the February retracement definitely does not.

Charles Dow’s original idea was to use the stock market to forecast the economy, where price action by the goods producers (industrials) was confirmed by companies involved in the moving those goods (railroads). It takes a long time to do this and an 11-day rally does not cut the mustard. The post January action may eventually qualify as a legitimate Dow Theory line, but that’s another matter entirely.  The first point then, is that the signal, even had it been triggered, would not have qualified. The second takeaway, is that the widespread publication of this potential sell signal means that it would has probably been already factored into the price structure. From a contrary aspect that's bullish.

Is the market forming a double bottom?

That brings me to the title of this article “Bottoms Up”, as Chart 1 shows the potential for a double bottom formation. The good news, is that few, if any people have written about it. If they had, I would be far more suspicious. It is normal for a genuine double bottom to be associated with very heavy volume on the initial dip. The second, should ideally be associated with great indifference, as selling dry up, and buyers avoid the market. Recent action certainly bears the characteristics of such a formation. That’s because the volume associated with the early February low was considerably less than that of late March. You can see this from the volume histogram, or from the fact that the PVO has so far been unable to rally above zero. By way of contrast the early February low experienced, an extremely high reading, indicative of a selling climax.

Chart 1

It could also be argued that last October’s price action represented a left shoulder of a head and shoulders top. It does not matter what you call it. If the March closing low is taken out and the Index remains below that new low in any meaningful way, prices would be headed south anyway.

For the double bottom theory to work we would need to see the Index rally back above that horizontal green trendline at 13,000 on the NYA (Chart 2).

One initial sign would be the ability of the Index to break back decisively above the (dashed) red trendline and 200-day MA. By doing so, it would indicate that the break was a whipsaw. Bearish false moves of this nature are usually followed by an above average rally.

Chart 2

Short-term indicators suggest the double bottom will be completed

Several short-term oscillators are offering a sporting chance that the potential double bottom will turn out to be an actual one. For example, Chart 3 compares the S&P Composite to its 12-day ROC. The green arrows flag previous recent examples when this indicator has reversed from at or below, the green oversold line. Close examination shows that the latest data has caused the indicator to reverse slightly to the upside. It's not quite a decisive signal yet, but baring a cataclysmic move a more decisive reversal is likely. This would then trigger its seventh bullish signal since 2013.

Chart 3

Chart 4 looks at the VIX, or rather its momentum in the form of a 10-day ROC. I pointed out in a previous article that the ROC reached a record high back in early February. The recorded data goes back to the start of the 1990’s, so that’s a pretty impressive performance. Now however, we see an even more potentially bullish development as the NYA dropped below its February bottom, but the VIX ROC did not take out its early February high. This means that there was clearly less fear in March than February, even though prices were lower, and that’s a positive.

Chart 4

Chart 5 also shows that breadth is holding up. First, both A/D lines came close to their January highs, whereas the Index fell short. These periods have been marked by the green arrows. Second the NYSE touched a new low in March, but the breadth indicators, as shown by the orange arrows, did not. That certainly does not guarantee that prices are headed higher but it is an encouraging sign.

Chart 5

The same idea applies to Chart 6, which compares the Dow to its diffusion indicator, a series that monitors the number of component stocks in a positive trend. It is also falling, but at an unsustainable rate, and is most likely close to a buy signal.

Chart 6

The big test for the DIA comes in the 25,000 area because that is slightly above the 50-day MA and green down trendline. If the average can hold above this level the odds of the double bottom scenario will have been greatly enhanced.

Chart 7

We know that indicators behave differently, depending on whether the primary trend is bullish or bearish. Since the major indexes are currently above their long-term MA’s, such as the 12-month span, I am assuming that the bull market is alive and well. That means that the indicators should respond to oversold conditions with a nice rally. If that does not happen, and the trend line in Chart 2 is severely ruptured we will have to re-assess the whole situation.

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 of Walnut Creek or its affiliates.