Beware The Ides of March - and an Overstretched Stock Market

• Strong Broadly-Based Rally
• NYSE Declining Peaks and Troughs Still in Force
• Several Short-Term Indicators Starting to Point South

Strong Broadly-Based Rally

The rally dating from Christmas Eve has been a powerful one, generating an approximate 20% gain from its low. It has also been broad, not only enabling the NYSE A/D Line to reach an all-time-high, but also allowing an A/D Line limited to common stocks only to achieve a similar feat.

Indeed, Chart 1 shows that the 45-day ROC for the NYSE Composite registered its highest reading since 2009. Previous instances when this indicator rose close to 20% or more have been flagged with the green arrows. All instances (except for the post 9/11 bounce in September of 2001) were followed by new bull markets or a very significant extension of an existing one.

Chart 1

I showed this chart in my Monthly Market Roundup Video, as it had a pretty good track record of scoring profitable buy signals. I like to test things back over really long periods in order to get a grip on how well indicators work over a variety of conditions, so yesterday I plotted this relationship back to 1925. On this occasion, I used the S&P, as it has a greater history. Usually things work out well, but the chart shows that the promising results of the post 1970s environment were not exactly replicated, as valid and false signals were evenly matched. On balance, though, the indicator’s ability to reach an extreme overbought condition is a plus, as there have been far more profitable instances than unprofitable ones in the last 90 or so years. One thing to bear in mind is the fact that all of the failed signals were quickly followed by a serious market decline, as the vast majority developed under the context of a primary bear market. Since a consensus of the long-term indicators that I follow have not yet moved into the bullish camp, that makes the current situation particularly interesting.

Chart 2

NYSE Declining Peaks and Troughs Still in Force

For example, Chart 3 shows that the NYSE has been tracing out a series of declining peaks and troughs since January 2018. It's true that the 2019 rally has taken prices back above the previous peak, but this approach requires us to see a higher peak and trough, which hasn't happened yet. This incomplete picture is not unlike last November’s higher low at “1,” followed by a lower high at “2.” The higher low at “1” certainly broke the declining bottom progression, but we needed to see both declining peaks and troughs reversed. That failed to happen, with the lower peak at “2.” In order for this technique to now revert to a bullish mode, we would need to see something like the hypothetical brown line in Chart 3, i.e. a successful test of the late 2018 bottom followed by a higher high. In order to qualify as a legitimate bottom, a decline from here would have to retrace between one- and two-thirds of the 2019 advance. In that respect, the extended thick red breakdown trend line represents an important support level and possible target. Ironically, a retreat back to that level would represent a Fibonacci 38.2% retracement, well within the 1/3-2/3 requirement.

Chart 3

Some form of retracement seems likely as Chart 4, featuring the DJIA, tells us that, in most situations, previous lows were tested. Consequently, it’s not usually a question of "Whether?" but "When?" and "How Much?."

Chart 4

Several Short-Term Indicators Starting to Point South

If we are looking for a correction, the end of the month-end bullish seasonal is not a bad place to expect it. Moreover, several short-term indicators have reached vulnerable levels. Chart 5, for instance, shows that the 14-day RSI was recently overbought and has begun to roll over. Though it did touch the overbought zone, the indicator surprisingly fell well short of the overstretched readings seen prior to the 2018-2018 bear run. We can also see in the lower window that the net new high indicator did not experience much of an expansion, commensurate with the exceptionally strong 2019 A/D Line and its own pre-January 2018 readings.

Chart 5

Chart 6 compares the S&P Composite to the number of NYSE stocks trading above their 50-day moving average. It is too soon to say that it is in the process of reversing, but there is no doubt that it has reached the kind of level where a reversal would likely signal a sideways trading range, as it did in the spring and summer of 2016, or an actual decline, as was the case in early 2018.

Chart 6

Chart 7 suggests the latter. The bottom window contains a 10-day ratio of the S&P 1500 A/D line. You can see that, to some extent, the price action preceding last September’s high is being repeated. First, the ratio is diverging negatively with the S&P Composite. Second, it has violated a small uptrend line. Most important of all is the fact that the final peak has (so far) been associated with an extremely low reading in the ratio. We saw a similar characteristic last September. Very weak momentum such as this is often followed by an above-average decline. I am not predicting one, merely pointing out that, when confirmed by some kind of trend break in the SPX, some unexpected weakness is possible. That trend reversal confirmation usually comes with an important trend line violation. Unfortunately, we do not have such a benchmark in the current situation, as the red line in Chart 7 is only a couple of months in length and has not been touched or approached on that many occasions. The 200-day MA, at 2750, looks to be a better bet as a signaling device.

Chart 7

One final thought: Markets here and around the world have been trading under the spell of positive expectations for a trade deal with China. That spell is likely to be broken when the rumors become reality. Perceptions would also change in the unlikely event that the talks break down. That would be unthinkable, so I won’t go there, but either way an overstretched market would find itself tempted to once more revert to the mean.

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.