Market Action Confirms the Employment Report

• Market Gets a New Lease on Life
• Ten-Day Breadth Ratio Hits Bullish Extreme
• S&P Stocks Above 50-day MA Also Hit a Bullish Extreme
• Can Small-Caps Extend their Sharp Rally?

Usually, when a market rallies sharply and experiences an overbought condition, the probabilities favor corrective activity of some kind. There are some situations, though, when these short-term oscillators move to an extreme, beyond the normal overbought readings. In such instances, they are actually long-term bullish, as they reflect a market possessing exceptionally strong upward momentum. We saw this on April 21, when the 10-day MA of a 12-day ROC for the S&P registered a reading comparable to that achieved just after the financial crash of 2009 (Chart 1). Those kinds of situations are certainly entitled to be followed by a small correction. However, their real message is about the rest of the bull market that lies ahead.

Market Gets a New Lease on Life

Last month, when the S&P was struggling with its 200-day MA, I pointed out that the 9-day RSI had not moved into an overbought situation and how that concerned me. As it turned out, my caution was unfounded, as the market has continued to rally ever since. Now, Chart 2 indicates that the RSI is firmly in overbought territory and no longer reflecting that bear market characteristic that had had me concerned.

In the intervening period, the S&P has crossed above its 9- and 12-month MAs, triggering two relatively reliable primary bull market signals. However, in recent days, more short-term indicators have moved into extreme overbought situations akin to the 12-day ROC smoothing experience cited earlier. In the vast majority of cases, this kind of action has been followed by significant market gains. I agree that such a possibility is difficult to accept after the 40% gain that has taken place since March, but history argues differently, so let's take a closer look at two more indicators.

Ten-Day Breadth Ratio Hits Bullish Extreme

The 10-day MA of the ratio of NY Stock Exchange advances to declines occasionally moves up to an extreme reading, as flagged by the green horizontal line in Chart 3. In most instances, such action comes well after the previous low, just like the current one, but certainly in time to take advantage of an advancing market that follows. The near-record reading strongly suggests that another powerful breadth thrust signal has just been given.

S&P Stocks Above 50-day MA Also Hit a Bullish Extreme

Chart 4 compares the S&P Composite to the percentage of stocks above their 50-day MA. Last week, it touched a record reading close to 97%. You can see that, in all previous instances when the indicator touched or exceeded the overbought dashed green line, stocks were in a bull market. There was one failure, as indicated by the dashed red line in 2010. Once again, market action is transmitting the idea that this is a young and vibrant bull market.

Over the weekend, I pointed out that the price oscillator for Part Time Workers was likely calling an end to the recession. The S&P has not yet touched a new all-time high, but the NASDAQ has. That's important because in 1960, 1980, 1982 and 1990, the stock market touched a new high around the same time their respective recessions ended. Following the first three examples, the market, on average, rallied for an additional 7-months before a meaningful correction materialized. In the 1990 case, it was almost 3 years. Combining this record with the powerful readings in the three short-term oscillators suggests that, notwithstanding small corrections along the way, the party may have just begun!

Can Small-Caps Extend their Sharp Rally?

In the last few weeks, small-caps, as evidenced by the Russell 2000 ETF (IWM), has started to rally sharply, both in its own right and relative to the S&P Composite. It's not yet sufficient to result in a reversal of the slow turning KSTs in Chart 5. However, the price itself experienced a whipsaw earlier in the year and has now managed to move back above its 65-week EMA. It's obviously overstretched on a short-term basis, but, given the positive indications for the overall market discussed above, may well be able to work its way higher.

The real challenge lies with the RS line in the third window, as it is very close to its EMA and a significant 2-year down trendline. If those benchmarks are breached to any significant degree, it would suggest that the long-term trend of underperformance by small caps has come to a close.

Price action by the Unweighted S&P ETF (RSP) argues that it soon will. That's because it has already moved above its down trendline, featured in Chart 6. If it proves to be valid, the breakout would strongly suggest that the recent superior performance of the technology stocks that have come to dominate the S&P has given way to a more populist message favoring the broader market, as represented by the IWM and RSP ETFs.

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.