S&P thinks there is a good possibility that the mid-July lows will be broken
From Standard & Poor's Equity ResearchWith the major indexes and many sectors bumping up against formidable overhead resistance, the stock market turned in quite a choppy performance last week. Stocks weren’t the only volatile asset, as crude oil was all over the place too.
This indecision in asset prices is an obvious reflection of the extreme uncertainty in the marketplace, as money rotates from leadership groups to underperformers and back again, almost seemingly every other day. Because of this price action, we are not getting the type of robust market internal readings that are many times associated with a key market bottom.
We, therefore, remain cautious, and worry that not only will mid-July lows be tested, but we think there is a good possibility they will be broken.
Many times coming out of a bear market, during the major reversal formation, you see an internal thrust where there is very strong levels of market breadth associated with both volume and advance/decline statistics. What we have witnessed at key bullish turning points is strong levels of advancing volume and strong levels of advancing stocks. This indicates a strong commitment back to equities as well as strong participation by many stocks, sub-industries, and sectors. We have not seen this since the rally began in mid-July, as money does not seem to be coming in off the sidelines. Rather, we think we are seeing strength fueled by short covering, and institutions are only rotating among different sectors.
So far in this rally off the mid-July lows, the NYSE 10-day exponential average of advancing volume (the fuel of a bull market) vs. total NYSE volume hit a high of 0.55 on July 23. This is certainly not an impressive ratio for a market attempting to reverse out of a bear market.
How does this ratio compare with the attempted bottom from earlier this year and other times when the market was reversing a downtrend? Compared with the early stages of new bull markets, the statistic this time is not very good. Strong readings on an absolute basis (higher than 0.60 generally) and increasing readings show institutions flooding back into stocks. In early February, coming off the January low, the 10-day advancing volume/total volume (10-day ratio) rose to 0.62. But coming off the March low, the highest this ratio got to was 0.59 at the pivot high in May, showing that buying was deteriorating somewhat during the second rally. Now, the 0.55 statistic from July 23 demonstrates further deterioration.
We think looking back at the last bear market bottom is even more telling. After the first bottom in July 2002, the 10-day ratio rose to 0.62, after the second bottom in October, the ratio got up to 0.60. But after the final low in March 2003, the ratio really started to strengthen and hit 0.63 in March, 0.64 in April, and had another 0.64 reading in June. The chart of this ratio showed a consistent uptrend in money coming back into the market, with a series of higher highs and higher lows during this entire basing period.
We saw a similar pattern develop during the 1998 market bottom. Off the August lows, when the ratio plummeted to 0.28, we had a quick and dramatic reversal with the ratio jumping to 0.56 in September. After the double bottom in October, the ratio jumped sharply back up to 0.62 as demand was strong on an absolute basis and versus the first rally attempt.
During the market low in 1990-91, the 10-day ratio put in a series of higher highs and higher lows after bottoming out at 0.28 in August, 1990. Coming out of the October low, the ratio rose to 0.59, and then after the final low in January, 1991, the ratio jumped to 0.65 in early February, 1991. Checking in on the August, 1982, bear market bottom, we had a nice increase in demand with the ratio hitting 0.64 in late August and 0.66 in October.
Analyzing market breadth, based on the ratio of advancing stocks vs. total issues during bottoms is somewhat consistent with the volume ratio we just went over. Again, strong readings on an absolute basis and increasing readings show institutions flooding back into stocks. During the rally in July, the 10-day exponential average of NYSE advancing issues/total issues rose to 0.55, slightly lower than the May high of 0.56 and firmly lower than the early February level of 0.60.
During the bottoming in 2002-03, the ratio bottomed in July, 2002, at 0.30 and then traced out a series of higher highs and higher lows into June, 2003. The ratio jumped to 0.55 in August, 2002, 0.57 in January, 2003, 0.58 in April, and 0.61 in June. In 1998, this ratio bottomed at 0.26 at the end of August, and then continued higher into November. In August 1990, the ratio bottomed at 0.21, and then consistently showed more and more strength into February 1991. At the bottom in 1982, the ratio jumped sharply after the final low in August. Interestingly, the August low for the ratio was higher than the June low while the S&P 500 was lower, giving a positive internal divergence. We saw this bullish divergence at some of the other bottoms we talked about, and is another clue for the technician. The ratio was slightly higher at the recent bottom in July then it was at the bottom in March. While prices were lower, which is a mild positive, we think it was not enough to get too excited about. When looking at similar ratios for the Nasdaq, we are just not seeing the same sort of statistics to indicate a major market bottom.
Crude oil was all over the place last week as it attempted to bounce off of minor support near $120 per barrel. This level represented pivot lows in May and June as well as a pivot high in April. It is also very close to a 23.6% retracement of the rally off the major low in January, 2007. Crude bounced back to an intraweek high of $128.50 on Friday, Aug. 1, before finishing at $126. We think the current counter trade rally will run into problems at chart resistance in the $130 to $138 area, and then turn lower and retest the $120 zone. We still think crude is vulnerable to correcting back into the $100-$120 zone before this move is finished. A strong break below $120 could usher in a move to strong support at $100. The next key trendline comes in down at $110, and is off the lows since August 2007.