Stocks: Bearish Signs Linger

Although there are nascent signs of improvement, long-term indicators still suggest that the bear market is not over

The major stock market indices bounced off of minor chart support last week, holding well above the mid-July price lows that we still think will be tested. The rally has been accompanied by extremely light volume, a negative in our view, but what can we expect from the last week in August?

We have gone over a lot of negatives in the last couple of weeks pertaining to sentiment, market internals, and incomplete reversal patterns. While long-term indicators take time to reverse at a major market bottom, and do not typically give you bullish signals until well after the final low, we thought it was a good time to sit back, enjoy the final days of summer, get the binoculars out and take a look at what these very important, longer-term technical indicators are telling us.

To sum it up very quickly, the long-term indicators we monitor are still suggesting that the bear market is not over, although there are nascent signs of improvement. One of our favorite longer term indicators, and a very simple one, is the 17-week and 43-week exponential moving average (EMA) crossover system in conjunction with the 43-week relative strength index (RSI). This system tends to keep you in the stock market during the main part of a bull market and keeps you out of the market during the main part of a bear market. However, it is not going to get you out at the top and in at the bottom -- that is not the function of a longer term indicator.

Bearish signals or intermediate- to long-term sell signals are set off when the 17-week crosses below the 43-week average, and the 43-week RSI crosses below the 50 line. During the week of Jan. 4, the 43-week RSI crossed below the 50 line, suggesting that the S&P 500 had rolled over into a major correction or bear market. The following week, the 17-week crossed below the 43-week average, confirming the weakness in weekly momentum and indicating that there could be further weakness in the equity markets.

Since those sell signals in early January, the 43-week RSI did jump back above the 50 line in May, but the 17-week average never climbed back above the 43-week average. The current conditions of this system are firmly bearish with the 43-week RSI down in the mid-40s and the 17-week EMA well below the 43-week EMA. With the spread between the two averages hitting 3.6% in early August, and similar to the reading we saw towards the end of March, it does suggest that prices may have fallen too far and that these oversold conditions could lead to a counter trend rally that is going on right now. However, both averages are still trending lower, and many times at the bottom, the 17-week average will flatten out and then start to rise before crossing the longer average, giving an early sign of a potential bullish cross.

Prior to the sell signal in January, this system last flashed a buy signal in early to mid-June 2003. In that year, the 43-week RSI crossed above the 50 line during the first week of June, while the 17-week EMA crossed above the 43-week EMA during the second week of June. The prior sell signal occurred in November 2000, right as the S&P 500 was rolling over into its severe bear market.

Another, even longer-term indicator for the stock market is the 10-month and 20-month EMA crossover system combined with a 13-month RSI. This system is even slower than the one we just went over, but has also done a good job keeping you in the market during the major part of a bull market and keeping you on the sidelines during the major part of a bear market. To enhance or quicken this system, we get an early warning signal when there is a monthly close by the S&P 500 below the 20-month EMA. This occurred at the end of January, well before the bearish crossover that happened at the end of May. Confirming that trouble was ahead, the 13-month RSI crossed below the 50 line at the end of January and is still heading lower. Both the 10-month and 20-month EMAs are also heading lower, indicating that any long-term buy signal could take months to develop.

We can add the monthly MACD to this discussion, and it tells us the same thing. This very long-term indicator gave a sell signal at the end of 2007, and just recently crossed below zero, confirming that long-term momentum is bearish.

As with any type of investing discipline, not all the indicators are one-sided. During the bear market, some of the market sentiment readings have dropped to extreme levels of fear and bearishness, an eventual good sign, in our view. We think a prerequisite to a long-term market bottom after a bear market or major correction is an emotional feeling of panic, despair, and depression among investors. We have seen these levels of emotion play out in some of the sentiment gauges we follow, as well as in the consumer confidence numbers we watch. The Investor’s Intelligence poll fell to the most depressed level in mid-July since the latter part of 1994, a very good time to get invested. In March, the Consensus poll fell to its most bearish level since 2002, while the MarketVane poll fell to its most fearful reading since early 2003. Total CBOE put/call (p/c) ratios almost reached all-time highs in March, while CBOE equity-only p/c ratios did hit all-time highs in March and April of this year.

Another potential longer-term positive is the action of the weekly momentum indicators. The 14-week RSI has traced out a bullish divergence after reaching oversold territory in January. While this indicator has put in higher lows, it has not yet broken the series of lower highs. The weekly MACD has also traced out a bullish divergence for the first time since late 2002/early 2003.

While there are signs a major market bottom may be in the works, from our vantage point, we think the overwhelming technical evidence suggests that the market has not dug itself out from the throes of the bear market.

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