When The Crowd Screams Recession, Technicians Should Prepare For A Bull Market

• Support Holds in an Oversold Market
• Most Sectors Still Experiencing Rising Peaks and Troughs

Last week, I pointed out that the stock market faced a challenge at its recent lows. This was because I saw that a breach of the solid red trend lines in Charts 1 and 2 would likely spell trouble for Global and US equities, respectively. Arguing against such a scenario was the fact that  several short-term indicators had reached an extreme. My conclusion was that the weight of the evidence argued for a rally, not a violation of the lines. In the intervening days, that view has been tested, with a lot of indicators now left in a strong position to support that elusive rally. Widespread fear amongst the general-purpose media about that dreaded recession also offers a strong contrarian foundation for a strong upside reversal.

Support Holds in an Oversold Market

Chart 1 shows that a price oscillator, calculated from my Global A/D line, has just reversed from an oversold reading. The arrows indicate that such action is usually bullish for the MSCI World Stock ETF. The red trend line and 200-day MA could yet be violated, but that seems unlikely given the oversold nature of the price oscillator.

Chart 1

The same principle holds true for Chart 2. It displays the NYSE Composite and my Bottom Fisher indicator. The Bottom Fisher (BF) calculates a universe of S&P industry groups with improving momentum and is only suitable for identifying bottoms. It does this by reaching an oversold reading and subsequently reversing to the upside. The BF is still technically in a downtrend below its MA, but does appear to have stabilized in the last couple of sessions. Again, it seems more likely that it will turn bullish than allow a violation of the solid red trend line.

Chart 2

Finally, Chart 3 compares the S&P to a 10-day ROC of the VIX. Swings in the momentum of sentiment, which is what this indicator reflects, can be very helpful in assessing when crowd psychology reaches an extreme. In this instance, the VIXROC triggers buy signals when it reverses to the downside from an elevated position. A buy signal of that nature was triggered a couple of weeks ago as the S&P fell to the 2850 zone for the first time. Compare that reading to last Friday's scary decline, which was associated with very little fear, even though the price fell to approximately an identical level. We interpret that as a bullish sign, as a form of positive divergence.

Chart 3

Most Sectors Still Experiencing Rising Peaks and Troughs

One simple and very much overlooked technique for trend identification is to observe whether the price of a security is experiencing a series of rising peaks and troughs. When that progression reverses to one of a series of declining peaks and troughs, it represents one piece of valuable technical evidence that the tide has turned. The top panel of Chart 4 tells us that the S&P has experienced a series of rising peaks and troughs since last December. That action clearly indicates positive technical characteristics. It's also a useful idea to see whether such action is being supported by a majority of the sectors and key industry groups.

Charts 4, 5 and 6 take a closer look at current action and show that the S&P is being supported by virtually every sector and key industry groups. Chart 4 reflects defensive sectors and groups, which have generally outperformed since December. This strong relative action by defensive areas is typical of an equity market emerging from a bear trend. Utilities, REITS and staples have all followed the upward zig-zagging characteristics displayed by the S&P. In addition, they have all achieved new bull market highs. Telecom is the standout, having begun a series of declining peaks and troughs. It clearly does not support the idea of a generalized market rally.

Chart 4

The sectors in Chart 5, for the most part, also reflect the higher peak-trough progression scenario. One area to watch is the financial sector, which is having difficulty remaining above its May low. This has been flagged by the horizontal blue arrow. It's still bullish based on this technique, but is facing an important test in the period directly ahead. However, cyclicals, industrials, health care and technology are in firmly bullish territory. Note that I am using the iShares industrial sector ETF, as the SPDR (XLI) combines industrials with transports in its portfolio. I prefer to split them, as transports tend to be a leading sector and industrials a lagging one. Placing apples and oranges in the same bag does not make much sense to me.

Chart 5

Returning to Chart 5, we see that one sector (energy) has started to trace out a series of declining peaks and troughs. If the markets do slip through those red trend lines in Charts 1 and 2, this weakness suggests that energy could well lead the way.

Metals and Mining (XME), as Chart 6 shows, has experienced a declining peak, but the rising troughs are still intact. The remaining groups in the chart, are continuing to experience a positive peak trough progression, though transports may be close to a break of their May low. Until the price does register a post May low, it is wiser to assume that the overall trend of rising peaks and troughs is intact. That May low is critical, though, since the IYT already experienced a lower peak in late July. A post-May low would therefore signal declining peaks and troughs.

Chart 6

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.