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August 5, 2012

High-Risk Market

Back in June, around the time stocks were forming their most recent intermediate-term low, I blogged a piece describing why the nature of that low would tell us what to expect later in the summer. Specifically, if the low went untested, forming a V-Bottom, the odds of seeing that low fail as stocks declined into their next intermediate low would be significant. We are no 8 weeks into the current intermediate cycle, and the action has quite clearly left a V-Bottom in its wake:

SPX Weekly Chart

Without getting too deep into details typically reserved for the Member Letter, cycle analysis suggests that if the current weekly cycle is to fail... meaning to drop below the June low... stocks will likely top sometime in the next two weeks. Furthermore, prices are likely to at least marginally penetrate the April high before rolling over.

A look at a few internal indicators shows a weakening market:

Stocks above 200-day moving average

The last two yearly cycle peaks showed declining participation as the number of stocks above their 200DMA failed to confirm new highs. The divergence is setting up to be more extreme this year, implying that perhaps a more significant top is in the works. Of course, we need to see new highs to establish the divergence, and then we must judge the nature of any correction before making call about longer-term tops.

Stock with bullish point-and-figure charts

As with the number of issues above their 200DMA, bullish percent is showing a particularly weak reading, sugesting that a larger downturn than anticipated may be in the works. Again, we still need more information before finalizing such a judgment, but more indicators support the case for a major top.

Small cap stocks diverge from large cap stocks

Semiconductor stocks diverge from S&P 500

Semiconductors displayed a similar divergence between 2006-07 just before stocks began a decline into a 4-year cycle low.

During secular bear markets, the declines into 4-year lows tend to stretch out over 18 to 24-months, culminating is a massive panic sell. We can never be certain that such a decline is about to begin, but risk in the market certainly seems high enough to warrant extreme caution. Any further strength in coming weeks would seem to me to be more wisely used as a liquidation opportunity than a trading opportunity.

 

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