It's Still a Bull Market, But More Corrective Activity is Likely

• Why the Correction Will Likely be Contained
• More Corrective Action Likely
• One Indicator Flashes a Buy Signal
• Conclusion

Why the Correction Will Likely be Contained

A couple of weeks ago, I wrote that a correction was inevitable, and presented a couple of indicators to suggest that it might be close. The main thrust of the argument, though, was that it would not amount to much. There were two reasons for that view. First, corrections in bull markets generally don't prove very significant, rarely exceeding 10%. (I emphasize the word "generally" because anyone who went through the 1971 correction in the 1970-1972 bull market could take me to task, as that was a particularly severe counter-cyclical correction.) Second, I pointed out that major tops were usually preceded by a divergence or two in the number of NYSE issues trading at new 52-week new highs. Chart 1 shows that no such divergence existed at the time.

Chart 1

In the last couple of weeks, we have seen a bit of a setback. Like all good corrections, this one has a believable rationale, which is to say that the potential spread of the coronavirus could likely affect the tentative recovery in the global economy. That means that, until the development of the virus breaks decisively one way or another, news about it is likely to continue as a random psychological factor, affecting swings equity market price swings in both directions. When we look at some reliable short-term indicators, the impression I get is that there will be more in the way of corrective activity before the bull market is likely to resume. Corrections can take one of two forms - either prices move down or they consolidate. Either way, it allows profits to be taken and excessive bullish sentiment to be worked off.

More Corrective Action Likely

One of my favorite short-term indicators is calculated from a 10- and 20-day SMA of the McClellan Volume Oscillator (MCO). Charts 2 and 3 show one for the NASDAQ and another for the NYSE. The green arrows show how, when these series drop to their oversold zones and subsequently rally, that typically translates to a price advance. Right now, the NASDAQ series is dropping, but is still short of an oversold reading. For its part, the NYSE MCO in Chart 3 is deeply oversold. That combination suggests that we may be close to a bottom. However, if you look at a lot of previous corrections, there is usually a test of the low prior to a more sustainable rally. Unfortunately, that does not happen every time, but some other indicators are suggesting that such a scenario may play out in the current situation.

Chart 2

Chart 3

First, Chart 4 features my Dow Jones diffusion indicator. This calculates the percentage of Dow stocks that are in a positive trend. Currently, it's in a declining mode, but is quite some way from an oversold condition. Action in 2017 indicates that a rally is possible without that condition being achieved. It seems to me, though, that it probably needs to correct further before prices are able to mount a meaningful rally.

Chart 4

A similar story is being painted by the daily KST, in Chart 5, where you can see that it is continuing to trade at a moderately overbought condition. Note that the October/January up trendline has been violated. This suggests a slowing down of upside momentum, which is also indicative of additional corrective action.

Chart 5

Chart 6 compares the S&P to a 10-day MA of the VIX. In order to enable both series to move in similar directions, the VIX has been plotted inversely. The green arrows tell us when the MA has fallen to the blue oversold line, which indicates greater volatility, subsequently reversing to the upside. The indicator currently is in a position to trigger a buy signal, as it's right at the line. However, it is still in a declining trend and has not therefore triggered a buy signal.

Chart 6

One Indicator Flashes a Buy Signal

One indicator that looks as if it has already turned is the 10 ROC of the ratio between the iBoxx High Yield ETF and the iShares 20-year Trust (_HYG:_TLT). This monitors confidence swings in the bond market. A rising relationship indicates that traders are in a risk-on mode, as they bid up junk bonds relative to treasuries. The chart shows that confidence was on the retreat way before the S&P peaked. However, it has now experienced a sharp jump from its oversold zone. The solid arrows indicate that such action is usually bullish for stocks.

Chart 7

Conclusion

Several indicators look as if they are about to reverse to the upside, others less so. Since the longer-term indicators continue to point to a bull market, it's probably best to focus on that trend, especially when a consensus of the indicators outlined in this article start to reverse. Please remember, it's possible for you to update these charts, net of annotations, by simply clicking on them individually.

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.