Is It A Short-Term Correction or The Start of a Bear Market?

• Two Indicators That are Not Yet Oversold
• Several Confidence Ratios are at the Brink
• Global Equities Probably Need to Test Their 200-day MA

In the third week of July, I wrote an article entitled "Is It Time For A Contra Trend Correction?" (currently unavailable). Initially, the market thumbed its nose at my assessment and proceeded to move a bit higher. Last week, however, brought it back in line with expectations. I was calling for a correction under the context of an ongoing bull market, but last week's action was more abrupt and severe than what I expected. The question now becomes one of whether it will be of sufficient magnitude to reverse the primary trend. There's an old Wall Street saying that "a trend is a trend is a trend," which basically means that we should assume that the prevailing trend is in force until proven otherwise. One benchmark we could use for the S&P would be a month-end close under its May low of 2750, since that would also result in a negative 12-month MA crossover. I don't think that's going to happen, but that's the kind of technical development required to trigger a primary trend reversal.

One of the reasons it seems likely that the correction will be contained, in terms of time, is that sentiment is rapidly switching to the correction camp. I notice this from a plethora of articles, on the web and elsewhere, triggered after a mere five consecutive days of decline from the all-time S&P high. That's quite a change in psychology. Also reflecting the recent fickle nature of traders is the CNN Fear and Greed Proxy. That series has dropped from 74% on 7/29 to 43% on 8/2 (Friday). At that rate of decline, it will soon reach rally-generating levels below 30%.

That's not enough evidence to conclude that the market will abruptly turn around and immediately move higher.

Two Indicators That are Not Yet Oversold

Indeed, two of the indicators that I had used previously to signal a correction have yet to fully unwind their overbought readings. Chart 1, for instance, features my Dow Diffusion indicator. This one monitors the percentage of stocks included in the DJIA that are in a positive trend. As you can see, it gave a reasonably timely sell signal, but, despite last week's selloff, is still registering an overbought condition.

Chart 1

Chart 2, featuring the number of S&P stocks above their 50-day MA, has corrected quite a bit, but remains some ways from the kind of overstretched condition that could reliably call a rally.

Chart 2

Several Confidence Ratios are at the Brink

I use a lot of relationships that monitor confidence in my work, which are useful because they often move in trends. Also, these indicators reflect what traders are actually doing instead of what they are saying. The first, as plotted in Chart 3, compares the iBoxx High Yield to the iShares 7-10-year Trust. A rising relationship indicates growing confidence and is, therefore, a positive force for equities (and vice versa). Note that it has fallen back from its June rally and is now positioned at its 2019 support trend line. The declining trend of the Special K suggests that the odds favor a violation of the line. That could be quite serious, as the ratio has experienced a substantial negative divergence with the S&P. This discrepancy has been flagged by the dashed arrows. Note also that the Index itself is right at the 2019 uptrend line, joining the December and May bottoms. If both series break simultaneously, that would be quite a serious development, as it would signal a renewed trend in deteriorating confidence and the S&P's sensitivity to it.

Chart 3

Chart 4 compares the S&P High Beta (SPHB) to High Quality (SPHQ) ETF. It's a relationship that is also resting on a support trend line. This one, though, is far more significant than that featured in Chart 3, because it is much longer and has turned back more declines. Note that this series has also diverged negatively with the Index. So far, the Index itself has not confirmed with a violation of its uptrend line. The current overbought reading in the Dow Diffusion indicator, though, suggests that it will.

Chart 4

Our third relationship compares technology stocks with staples. Once again, a rising relationship indicates that traders are favoring the higher-risk tech stocks over the more sedate and predictable consumer staples. The green-shaded areas (identified with the benefit of hindsight) show that a rising relationship represents a more reliably bullish signal for the S&P than either the junk/treasury spread or the high beta/high-quality relationship.

This ratio broke out from a 15-year base in 2017 and immediately proceeded to move sharply higher. It has been in a trading range for the past year, as flagged by the two converging trend lines.

Chart 5

Chart 6 shows that range to be a potential reverse head-and-shoulders, the completion of which would not only signal a higher ratio but a more buoyant S&P as well. Note that the 65-week EMA is currently at the same level as the uptrend line. This convergence of support areas increases its significance. Currently, the short-term KST is hesitating but still bullishly above its signal line. It's going to be interesting to see in which direction it breaks out. Remember, you can update this chart (or any other chart in the article) simply by clicking on it.

Chart 6

Global Equities Probably Need to Test Their 200-day MA

Global equities have also been hit by the latest setback. Chart 7 shows that the MSCI World ETF (ACWI) has experienced a false break above the neckline of a consolidation inverse head-and-shoulders. Friday's action saw a tentative confirmation, with a violation of the 2018-19 uptrend line and a more severe rupture by the global A/D line. Whipsaws are typically followed by above-average moves in the opposite direction to the false signal, as traders seek to unwind their losing positions at any cost and reposition themselves in sympathy with the new trend. Applied to the current situation, that could well mean a quick and scary test of the 200-day MA.

Chart 7

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 Groupof Walnut Creek or its affiliates.