The Correction May Well Extend, But Some Green Shoots are Starting to Appear

• Some Signs of Weakness
• On a More Bullish Note
• Mind that Gap and Volatility

Last time I wrote about the stock market was the first week in February, where I concluded that a couple of indicators were oversold, but that many others were not, so further corrective action probably lay ahead. Chart 1 shows that, if you measure the market through the NYSE Composite lens, that conclusion was not far off. On the other hand, if the S&P or NASDAQ are your preferred indexes, my analysis was less impressive, as they went on to register marginal new all-time highs. There's no doubt, though, that the whole market has been in corrective mode this week. The dichotomy between these three series emphasizes the point that it is difficult to define, let alone accurately call, a counter-cyclical correction, especially when as ferocious as this week's retreat. The achievement of new highs in the $SPX and $COMPQ, along with the failure to confirm by the $NYA, throws up a negative divergence that was not present before.

Chart 1

Some Signs of Weakness

Chart 2 shows that the NYSE Common Stock A/D and the NYSE Upside/Downside lines both failed to confirm record highs in the SPX. That's not necessarily the kiss of death, but it does reverse one previously bullish point that no divergences existed.

Chart 2

Furthermore, a negative divergence developed between the NASDAQ Composite and the NASDAQ bullish percent in Chart 3. Note that the bullish percent failed to cross above its 20-day MA, as the Index itself was registering a new high. It has subsequently dropped to a decisive new post-early February low, thereby indicating a technical structure with a very weak underpinning.

Chart 3

The same failure to cross the 20-day MA characteristic is present for the bullish percent of NYSE issues. Chart 4, however, shows there was no actual divergence between the indicator and the $NYA. It's worth noting that  neither of the bullish percent series are close to even a moderately oversold condition. There is nothing in the rule book that says they have to fall that far, especially in a primary bull market, but it would certainly raise my comfort level in forecasting a rally if it had.

Chart 4

One indicator that went bullish in early February was our 10-day SMA of the McClellan Volume Oscillator. Chart 5 shows that, while it did rally, it nevertheless failed to move above the equilibrium level, which is a sign of a tired market. It is now in a declining trend below its red 20-day SMA. I am watching it closely to see if it sets up a positive divergence with the S&P. Remember that you can click anywhere on this linked chart for an update whenever you wish.

Chart 5

Chart 6 features my Dow diffusion indicator, which monitors the percentage of the Dow 30-stocks in a positive trend. The green arrows show that it has had a good track record for calling rallies when it has reversed from an oversold condition. Right now, of course, it is in a negative trend and is some way from an overstretched reading on the downside. It doesn't have to fall that far, obviously, but it would improve the technical position if it did.

Chart 6

On a More Bullish Note

In the meantime, it's worth noting that the 9-day RSI for the Dow ETF, the DIA, is oversold. Provided the main trend is still bullish, which the vast amount of long-term evidence supports, that oversold reading should generate some form of retracement rally. The lower window shows that the price volume oscillator (PVO) has already reached an overbought level, which, in a declining market, is indicative of a selling climax. In that respect, the chart indicates that an oversold RSI and a peaking PVO are usually followed by a worthwhile rally of some kind. At the moment, the PVO is still rising, so we cannot yet say that it has peaked. Usually, when it reaches the green overstretched line, an actual peak is not that far off.

Finally, Tuesday's action took the DIA back to support in the form of the extended breakout trendline and its 200-day MA. Note that unlike the DIA, which includes dividends, the actual Index ($INDU) did breach its 200-day MA very slightly.

Chart 7

Mind that Gap and Volatility

Chart 8 shows that Monday's action left a large gap. Gaps are emotional affairs, as buyers or sellers are so strongly motivated that they bid prices up or down well beyond the trading range of the previous session, thus leaving a blank space on the chart. Just as two people having a ferocious argument usually calm down and re-visit those emotions, gaps are usually filled or an attempt is made to fill them. In that respect, the blue arrows show that, in all cases, in the last few months' gaps were eventually filled. Note that a huge gap was left earlier in the week. We never know when a specific one will be filled, but usually it's within a week or two. That should add a smidgen of hope to a pretty rotten last few days.

Chart 8

Chart 9 features the 10-day ROC of the VIX. The vertical lines show that when it reaches an extreme and then reverses, there is an excellent chance that the decline is over. Right now, the ROC is well into overstretched territory, but it is still rising. It too should be watched for a possible reversal. A reversal wouldn't guarantee a rally, as the October 2018 and May 2019 experiences tell us, but it will certainly increase the odds. Once again, click on the chart if you want to update it.

Chart 9

Finally, Chart 10 features a great indicator that I spotted on scottgrannis.blogspot.com earlier today,  calculating the ratio between the VIX and the ten-year yield. As you can see, it is at the highest level since 2011, which indicates a substantial amount of fear. Even though we may need to make an allowance for the fact that its high current reading may be due to the historically low 10-year yield, it's still at an impressively fearful and therefore positive level. It is also a very consistent indicator, as every time it reaches the green line, the S&P stops falling and begins to form a base. More typical is the fact that reversals from at or above the horizontal line correspond with low points in the market. The indicator has obviously already entered the "green" zone but has not yet reversed. When it does, I would expect to see the formation of a base, which would then allow for some of the indicators described above to reach oversold levels. On the other hand, don't be surprised at a quick upside reversal.

Chart 10

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.