It's Time for a Rally, But that Comes with a Catch
The stock market's recent sell-off has made the front pages and top headlines in TV broadcasts, and CNN's famous Fear and Greed Index has fallen to an extreme level of fear. My contrarian bones say it's time for a rally. Is that right? Yes -- but! The big question is whether it's the end of a mini-bear market or, more likely, a short-term or intermediate relief rally. I am leaning towards the latter two possibilities, because the longer-term indicators are still pointing south.
Take Chart 1, for instance. It shows that the S&P is well below its 12-month MA and the long-term KST is bearish. To be sure, these indicators will give us a false sense of weakness should this bear market turn out to be something in the order of a 2011-12 or 2015-16 decline. Nevertheless, you can see that the big bears of 2000-2002 and 2007-2009 never experienced a positive 12-month MA crossover until they had completed their downward trajectory, and the KST was well below its equilibrium point. As long as the consensus of primary indicators I follow are negative, as well as showing no prospects of an imminent reversal, caution is usually the best policy.
Market Due for an Oversold Bounce
There are a couple of indicators that reflect the market's current oversold condition. First, Chart 2 features the CBOE Options Total Put/Call Ratio, or, rather, its daily KST. A rising indicator reflects a trend of growing pessimism as market participants feel more and more comfortable in buying puts. However, when that trend starts to reverse, it usually coincides with some kind of a bottom. The dashed arrows flag reversals that take place from at or slightly above the blue horizontal line. The solid ones reflect greater pessimism, with reversals that develop at or above the dashed green line. All these situations were followed by a rally of some kind, rendering it a pretty reliable indicator. The fact that it has recently reversed from an extreme level is therefore encouraging.
That said, you can also see that the two red-dashed arrows were not followed by much of an advance, as these signals were triggered at the start of the 2022 decline. When a normally reliable short-term indicator such as this triggers false positives, it is a sign of a bear market and a warning that future bullish signals may return a similar result.
The same can be said for the Bottom Fisher (!PRBFISH) that you can read about here.It goes bullish when it reverses direction from a position under its horizontal green dashed line. Examples of buy signals have been flagged by the dashed green arrows. The "Fisher" has just gone bullish again, but comes once again with a caveat.
That's because Chart 4 shows how it operated during the 2007-2008 bear market. We can see a total of four signals being generated. Because this was a bear market, the first three were counter-cyclical in nature; only the one triggered in July 2008 was able to advance for as long as four weeks. The fourth signal, in March of 2009, was spot-on. That's because it developed a few days following the final low, i.e., in a primary bull market. At that time, of course, the long-term primary indicators, such as the KST, were oversold, not overbought as they are now.
Bearing that in mind, Chart 5 shows that Friday's action proved to be a hammer candlestick. I think of these one-day patterns as normally having an effect for between 5-10 sessions. If that proves to be the case here, it would buy sufficient time to enable some of the other short-term indicators to turn positive as well. In this instance, it would enable the RSI to complete a small base, similar to its action earlier this year as it signaled the March rally. As to how far any advance might go, I am looking at a possible 61.8% retracement to the 50-day MA, and green trendline in the area of the late April/early May highs at 4,300.
Such a rise would also take the average back to its imprecise late April breakdown point, as illustrated in Chart 6. That's not a prediction, merely a possibility.
Market Turning Points Often Associated with a Change of Leadership
It is a fact that market turning points are also associated with a change in leadership. In the current situation, we can point to one possibility. In that respect, Chart 7 compares the US market, in the form of the S&P Composite, to the World and two "Rest of the World" ETFs. The long-term trend favoring the US remains intact, but it is evident that all series have violated their 2022 up trendlines. Since these ratios often move in a similar direction to the US Dollar Index, these breaks hint at a correction there as well.
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.
