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Non Believers Beware. Charts Say Important Bottom Is In Place.
By Joe Duarte - Publisher and Editor, Joe-Duarte.Com
joe-duarte.com Oct 11, 2002 6:45:00 PM Email this article Print this article
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Sentiment Summary
The CBOE Put/Call ratio gave a reading of 0.97 on 10-10, a reasonably high reading, and one that rose from its prior reading despite a nice market rally. This is a good sign for the short term. Under normal circumstances a series of high numbers on this ratio, such as what we have seen would be enough to rally the markets, but that has not been the case lately, until the last few days, and begins to confirm our impression that as investors give up on the significance of indicators, they will start to work again.
But this is not the time to jump up and down and celebrate. This is a very delicate time for this market. Investors should watch this indicator closely in the next few days. If it drops rapidly as the market rallies, it could be telling us that the rally has no staying power. The CBOE Put/Call ratio gave two readings below 0.60 on 8-19 and 8-22. These two relatively low readings suggested that the market was slightly overbought, and correctly predicted the sell off that began on 8-23, which led to the huge sell off on 9-3, after which the market stabilized only to fail again on 9-12. Readings below 0.5 are of concern, but not as serious as readings below 0.40. The recent major market bottom, July 24th, was nicely predicted by the large ratio of 1.14 on 7-19. There had been some good readings prior to the 7-19 reading including the 1.08 readings on 7-2 and 7-8. These followed the 1.27 reading on 6-21, and other high readings such as 1.15 on 6-14 and 1.08 on 5-28.
The CBOE P/C ratio for indexes was 1.72 on 10-10, its 22nd bullish reading in a row after a bearish reading of 0.89 on 9-10 which correctly signaled the market‘s fall in mid September. The low reading on 9-10 ended the bullish reading streak of this indicator at 35 out of the last 37 days, and suggested some short term uncertainty in this market was possible. Readings below 0.9 suggest too much bullish sentiment, just as readings above 2 are usually required to mark major bottoms. The index did fall below 1.0 on 8-11, but did recover over the next few days. If the market sells off, we want to see this indicator give very high readings, especially if there are readings over 2.0. This indicator was also bullish for 75 out of 77 days prior to 12-17, as the market made a nice recovery off of the September bottom.
The VIX and VXN indexes checked in with readings of 46.29 and 62.82 respectively on 10-10. These are high enough to trigger a short term rally, and should be watched carefully for the speed at which they fall. It would be ideal to get a nice rally on 10-11 and to have VIX and VXN stay above 40 and 60, as that would show that the non believer ratio is still high. If VIX closes above 40 and VXN above 60, it often suggests that a trading bottom is near, or that volatility is on the rise. In the last few weeks, high readings on VIX and VXN have led to high levels of volatility, but have not marked a bottom. The VIX reading above 50 on 7-23 was a sign that true fear had arrived, and that a market bottom was near. On 7-24 we had the nearly 500 point up move on the Dow. The September 2001 bottom gave us a reading of 57 on VIX also marking a significant market bottom. A fall below 20 on VIX and 40 on VXN would be very negative, especially if the market rallies.
Newsletter writers are increasingly more bearish, for the reporting week of 10-4, as polled by Investor‘s Intelligence. This is encouraging, as newsletter writers have yet to throw in the towel. In contrast to the newsletter writers, the futures traders polled by Market Vane have stayed bearish for months, although their bearishness receded during the past month.
Chart Courtesy of StockCharts.com
Technical Summary
The S&P 500 held above 775 and powered its way above 800. If the market holds and the up trend can reassert itself it could take the index to the 869-882 area. Key long term support remains at 775, the July 23, 2002 lows. And this is the really important place to watch, for a break below 775 would be a death blow for this market and could set off true panic selling. Nasdaq also bounced as it also held above its recent lows. The small stocks are likely to move along with the markets, but may get a little help if the dollar remains steady.
What's Happening
As the leaves begin to turn, and young trader’s fancies turn from short selling to short covering, Wall Street looks to have turned the corner, at least for the short term. The bottom line? Don’t bet the farm, but start getting that shopping list out of the closet and into your hot little hands. And warm up that rusty index finger and mouse. Santa Claus may be coming to Wall Street early.
The best thing about this two day rally is that it could be a two day rally, or a two month rally. The doubters are all but completely in agreement that this is another fake out, and that the July lows will not hold. But the chart of the S&P 500 shows that this is likely to be a classic W bottom, and that the rally could well last longer than most people expect.
The technical evidence for this to be a credible bottom is strong, and subtle, meaning that a significant number of people will both miss its presence, and or ignore and dismiss it if they note it. First, the 775 area on SPX held. Second, neither did the MACD or the MACD histogram, pictured on the lower part of the index chart on this page, did not make a new low, even as the index made a marginal new low. More impressive is the positive divergence on the Nasdaq Composite chart, also on this page. This index made a signficant new price low below its July bottom. But its MACD also made a higher low. That qualifies the July low as the momentum bottom, and the October low as the panic bottom, where the proverbial capitulation took place. That means that this is a rally that only a handful of folks believe could last. And this is evident by the fact that the press continues to forecast the end of the world as we know it. Put/Call ratios for indexes and individual stocks continue to suggest that pessimism is high. And the volatility indexes are still telling us that a big move is coming.
Where to concentrate if this rally continues? Relative strength is in health care and biotech. But energy and technology are very oversold and could also provide interesting opportunities. Our subscriber sections are full of ideas and are highly recommended.
The caveat? External events could turn ugly as tensions are rising in Kuwait and elsewhere in the Middle East. Also look for increasing political pressure as the elections near. The Democrats threw in the towel in the Senate and one more bit of uncertainty has been removed, as President Bush now has Congressional support to authorize an attack on Iraq if necessary. But the opposition will be attacking the economy with heartfelt anger in the next few weeks as the potential for a Republican majority in both the Senate and the House is increasing.
So far, no major negatives on the earnings front have been revealed. General Electric came through with no nasty surprises on its earnings report, and followed what seems to be an emerging trend of better than expected earnings. Yahoo and Aetna also came in with surprisingly good numbers on the prior day. Never mind the fact that last year’s earnings or in most cases losses were so pathetic that comparisons were easy. As they say in the world of sports, a win is a win.
Finally, we will repeat what we said on 10-9. There are only two choices for the market, either we have a huge meltdown and all hell breaks loose, or we are possibly days away from a major bottom, and perhaps the end of the bear market. One of the most savvy market observers of the modern era, UBS’s Art Cashin, a frequent guest on CNBC described the market action on October 9th, as one in which there was “real disillusionment.” To us that means that the current market psychology has gone beyond fear and disgust. To us that says apathy. And that means that a significant set of developments is about to unfold.
Chart Courtesy of StockCharts.com
The broad based Value Line Index (VLE) closed above 850 getting back much of what it had lost on the prior day. Resistance is at 875-920, with the potential for a move to 975 on a break above 950. The next down leg, if the index breaks below 800 could take the index to 700. VLE is an important measure of the broad market as it gauges the performance of 1700 stocks, and is not market capitalization weighted. That means that it is a true picture of what is happening to a very broad base of stocks, and not just affected by the movement of one or a few major stocks.
Our asset allocation model is still recommending a 20% exposure to stocks, an allocation that has been very useful, as even those who have gone long on stocks have been protected by high levels of cash. But that cash horde may come in handy in the next few days. MASI is still on a buy signal, telling us only that the market is oversold. MASI has been less than its usually reliable self of late, although its sell signal in May 2002 and correctly predicted a 27% decrease in the S&P 500 that ended on July 24, 2002. MAGI, our intermediate term sentiment gauge is near a sell signal. Conflict between the two indicators is often a signal that risk is actually rising. The MAGI indicator has proven itself many times and its most recent sell signal was good for predicting a 22% decline in the Nasdaq since it turned negative in November 2001, until the indicator bottomed in June. The NYSE Specialist data for the week of September 20, 2002 was very positive. The specs decreased their short selling and bought stock more aggressively. The latest data, is always released with a two week lag.
MASI is a short term sentiment indicator based on the sector index options, while MAGI is an intermediate term sentiment indicator based on the weekly readings of Investor’s Intelligence poll of newsletter writers. MASI’s sell signal from 5-3-02 was an excellent predictor of the market’s fall, which actually began on 5-17, and although MASI turned bullish on 6-14, the sell signal preceded the 27% decline in the S&P 500 that ended on 7-24.
Chart Courtesy of StockCharts.com
The Amex Biotech Index (BTK), again exerted its relative strength jumping nicely after having held support in the last few days. We like this area a longer term basis. BTK has now distanced itself nicely from the support area at 300 and is testing the 320-340 resistance area, above which it could move to the 360 area in a hurry. A break below 300 could take the index to 275. We continue to like the long term prospects for biotech, as new lows seem unlikely. Long term investors should be compiling a buy list and could use this basing process to nibble on selected stocks. We See our premium Health and Biotech digest for full details and a newly updated list of both long opportunities and short sales for biotech.
Chart Courtesy of StockCharts.com
The Amex Pharmaceuticals Index (DRG) is also a fountain of relative strength in this market, and money continues to flow steadily into the drug stocks. This index remains in better shape than the rest of the market, and again showed signs of life on 10-10. Key resistance is at 300-320 area, while support is now at 270-280. A move above 320 would be a welcome development, as that would take the index above the 50% retracement point from the recent bottom, and would be a sign of strength. For a full description of the ins and outs of investing in biotech and pharmaceutical stocks check out our book "Successful Biotech Investing", available at amazon.com, barnesandnoble.com, and bookstores everywhere.
Chart Courtesy of StockCharts.com
The chip stocks finally bounced as they were so oversold that it was not if but when it would happen. the Philadelphia Semiconductor Index (SOX) has enough room to produce as much as a 20% bounce from its 10-10 close before deciding what to do. Trading is likely to be fast but full of opportunity for nimble traders. The index has registered an 83% loss since the top in the year 2000. Full timing details on both going long and short on technology stocks using the Merrill Lynch HOLDRS trusts, SMH, BBH, and the QQQ’s, visit our technology timing section.
Chart Courtesy of StockCharts.com
The Philadelphia Oil Service Index (OSX) and the integrated oils (XOI, see below) once again held at the bottom of their multi month trading ranges. OSX has been forecasting a break in the price of crude oil, and this scenario continues to unfold, as the $30 price area becomes tough overhead resistance. Our OIH timing model has produced a 48% cumulative profit for 2002, as of September 27. The system has produced gains of over 62% since October 2001 when it was established. See our subscriber section for full details and our trading results below for the latest data on this system.
The energy markets continue to provide news items. Venezuela is on the verge of anarchy. U.S. troops are under harassment in the Middle East but are reportedly being deployed as an attack on Iraq is now deemed as unavoidable. Winter is fast approaching, and natural gas prices are holding above the $4 price area. The keys to the oil and energy markets, along with profiles, and analysis, of the key fundamentals, and leading companies as well as the increasingly complex political factors and influences on the energy sector are discussed in detail, in our latest book "Successful Energy Sector Investing" (Random House/Prima Venture) .
Chart Courtesy of StockCharts.com
The Amex Oil Index (XOI) closed above 430 on 10-10, and will be worth watching for seasonal trading opportunities in the next few weeks. A move above 500 for XOI would be a very bullish development for the energy complex. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.
Chart Courtesy of StockCharts.com
The S&P Small Cap 600 index bounced back on 10-10 and could continue its recent rally on the back of a strengthening U.S. dollar. The dollar is an important influence on small stocks since this macro sector of the market tends to rely on domestic business rather than international money for its earnings. Larger multinational companies tend to benefit from a weaker dollar as it aids exports.
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