An Intermediate Oversold Condition Suggests That The December Low Is Likely To Hold For Several Months

• Short/Intermediate Oversold Condition
• High-Low Data Reaches an Extreme
• The Bear is Still With Us Until It Isn’t

As we all know, markets have a strong tendency to swing from excessive optimism to extremes of pessimism. During the last month, we have certainly seen a substantial amount of pessimism as wild downside predictions, unthinkable as the S&P was trading near its September high, became widely publicized. When the general-purpose media prominently report on sharp market declines during daytime programing, as has recently been the case, it’s a fairly safe bet to conclude that the bear argument is well understood and that it’s time to be looking in the opposite directions.

Hard facts, in terms of some of the short-term internals, support the idea that some form of rally is in the cards. If this is a bull market, we have just seen the kind of numbers that represent an outstanding buying opportunity. If it’s a bear market, then look for a rally that will fool the majority before hitting new lows.

Short/Intermediate Oversold Condition

Chart 1 features the 30-day MA of the Put/Call ratio ($CPC). The green arrows clearly demonstrate that, when the ratio has reversed from a high level, a meaningful rally has usually followed. The red-numbered advances all developed during the course of a bear market and were noticeably less powerful than the other signals. Another peak appears to be forming right now, but note that the previous one, late last year, was only able to generate some ranging action, not the usual advance. While a stronger rally is likely from the current signal, there can be no mistaking the fact that the weak year-end action was a characteristic of a bear market. It’s not overwhelming proof of one, just one piece of negative evidence in the probability pie.

Chart 1

Sentiment also reflects itself in volatility, as featured in Chart 2. Here, we see the so called “fear” index, the VIX, plotted inversely in order to correspond with swings in the S&P. The black line is a 10-day MA of the raw data, while the red one is a 15-day smoothing. The green arrows show upside reversals that have taken place at or below the blue horizontal line at the 16 level. Solid arrows reflect valid signals while dashed arrows reflect weak rallies. Right now, it looks as if we are about to witness another positive signal, but it’s as well to remember that the previous one was only followed by a trading range, not a full-fledged advance. Failed signals such as that are more characteristic of a bear market than a bull.

Chart 2

Chart 3 features my Dow Diffusion indicator. This one monitors the Dow stocks that are in a positive trend above their intermediate-term MA. The green arrows flag periods when the indicator reverses to an upside direction from a reading at or below the green-dashed horizontal line at the 20 level. This indicator is also very oversold and has started to ever-so-slightly reverse to the upside, hinting at a rally. Note that the weakest signals in the last 10 years all developed under a bear market context. Signals that were triggered during a bull trend (which are most of them) all represent excellent buying opportunities.

Chart 3

High-Low Data Reaches an Extreme

One characteristic of the December market low was a huge expansion of issues registering net new lows. It reached such a degree that, if my assumption of an ongoing primary bear market is correct, December will, in retrospect, have seen the maximum downside inflection point.

Chart 4 shows a 10-day MA for the high/low ratio on the NASDAQ. Note that the 2015-16 and 2018 tops were both associated with lower numbers of stocks registering net new highs. Equally as important, the actual bottom experienced fewer stocks at new lows, thereby indicating that the selling was less intense, despite the Index taking out its previous low.

Chart 4

Chart 5 shows a similar measure for the NYSE Composite for a much longer time period. The six sets of green arrows point out that it is normal for final bottom in a price move to experience fewer issues registering net new lows. The fact that it hasn’t happened in the current situation is no guarantee that December was not “the” low, but I would be much happier coming to such a conclusion had the market experienced its usual positive net new high divergence.

Chart 5

The Bear is Still With Us Until It Isn’t

Chart 6 features the NYSE Composite together with a 14-day RSI. It underpins a number of points. First, the red and green arrows show that the NYA has been tracing out a series of declining intermediate peaks and troughs. Second, unlike the Dow or the S&P, which have been dropping off for just three months, this Index has been in a bear market for about a year. It is therefore well advanced in its downward trajectory.

Third, the approximate trading bands for the RSI differ in a bull and bear market. For example, it reaches the overbought zone and stays there for mush longer in a bull market. Oversold conditions are rare. The opposite has been true since last January’s peak, since this oscillator has only touched the 70 overbought zone once and quickly retreated. On the other hand, red oversold readings have been plentiful and barely able to generate much in the way of a rally. Until we can see a resilient overbought reading or two, the characteristics remain bearish.

Finally, note that the NYA has completed a major top. At this point, the rally looks to be a normal retracement back towards that overhead resistance at 12000. One piece of evidence that would point to a reversal to a primary bullish trend would be a series of rising peaks and troughs that take the Index back above the red breakdown trend line.

Chart 6

Charts 7 and 8 show a similar exercise for the S&P and the Dow. The major difference is that both these series peaked late last year. Interestingly, the two RSIs experienced similar characteristics to the NYA, even though the other two were technically in a bull market between January and October of last year. Resistance for the S&P lies at 2,640; for the Dow, it is around 24,500.

Chart 7

Chart 8

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.