Weekend Review 05/18/12

The market has been running on fumes since late February and was in need of a cleanse. The move from late December to January was swift and since then the number of stocks that continued to lead the indexes higher was becoming increasingly narrower by the month. The Russell continued to lag indicating a lack of risk appetite as small caps fell out of favor and money flowed continually into big cap tech.

This week closed out with all major indexes having pulled back at least 10% over the past two months. In addition this week ends with a number of breadth indicators denoting that the market is oversold and a bounce on the near term is highly probable. So based upon general principles it would seem that a tradeable bounce to the upside is on the horizon this week but whether or not this stabilizes a near term market bottom to rebuild constructive bases off of is debatable.

In addition this week ended with all major indexes confirming Stage 4 Markdown by closing below their 30-Week moving average. Using the Russell over the past two years we can see that in 2011 the first close below this average did indeed lead to a bounce that lasted four weeks before rolling over and ultimately breaking the pivot low before eroding much further. Also of note, over the past two years there the Russell ended this week very close to where it closed 2 years ago. While there has been oscillation between this period, essentially the Russell has been in a wide range.

Russell 2-Year Weekly

Two other pieces of information this week that caught my eye were the USHL and the T2107 (the number of stocks above their 200 period MA.) which indicate that the market internals are not confirming market exhaustion. Comparing these numbers to a year ago, internally the market structure is not dissimilar to where it was in early August after the first wave of selling hit in late July. So while a number of breadth metrics indicate the market is oversold on a technical basis and a bounce may be on the horizon, it clearly has not reached exhaustion nor capitulation as a number of stocks are still holding up well enough as of now.

USHL 05/18/12

T2107

Further evidence comes from the Market Monitor Primary reading which has yet to reach the extreme readings from August through October of 2011. This affirms that there are still a number of stocks this correction has yet to ding. Until this breaks down further, the hypothesis is that any bounce will be reflexive and that the market needs to erode further then take time to rebuild bases before a sustainable move to the upside can begin.

MM Primary 05/18/12

  

Overall it is abundantly clear the market is in bad shape and has the potential to erode further.  While a 10% pull back is a sign to become optimistic, there's no reason why things can't continue down another 5% or more.  The persistent selling over the past two weeks has been methodical and while there have been pockets of capitulation in some individual names there hasn't been urgency to unload at any price.  The conditions are there however, just as there are conditions for a bounce so the reaction to either of those scenarios will give further clues as to how this will play out.