Trending higher

As expected we had a pause before resuming the trend higher. The McClellan Oscillator is constructed the same way as a MACD - it is the difference between two moving averages (of the advance-declines). When it becomes "overbought" like it is now, this is not necessarily a sell signal. It is an indication that the shorter timespan average is still increasing faster than the longer timespan average and is pulling it higher. Again the shorter term component, the 10% Index has gone above +500 which indicates the trend remains strongly higher -- even though we could have a short term correction at any time. As the rally matures, the upward trends of the two MCO components tend to merge (the MCO declines) but as long as the 5% and 10% Index values stay positive the rally will continue to coast higher. The previous chart markups are still relevant.

The McClellan Oscillator
Click to enlarge

MCO Update

The reversal pattern continues to develop. The McClellan Oscillator finished the day with a +300 reading. This is in the overbought zone and offers the potential for a corrective move. The question at hand is how deep the correction might be. One factor to be considered is that the last overbought peak was in the +250 area and led to a fairly deep correction. Scanning across the chart to the left one might be inclined to think this would be the case again.

Two factors seem different to me this time. First, the MCO made higher highs this time (while the index didn't) which I interpret as a sign of increasing momentum on the upside. Second, the 10% Index finished at +668 which means that market breadth is very strong to the upside and that after any interim correction prices will move higher. At the previous MCO peak at +250 the 10% Index failed to get above +500 -- indicating that fewer issues were participating and that sentiment towards stocks still remained weak with sellers rushing in to unwind long positions. The initial MCO spike to +250 was probably short covering.

I would also note that sentiment measurements (AAII, II etc) are still bearish indicating that this rally has a ways to go on the upside.

The McClellan Oscillator
Click to enlarge

SPX cycle chart

A 65 minute chart of the SPX with various time cycles
drawn in as vertical bars. Click to enlarge

The data set goes back to 2007 and the cycle periods are visually fitted to the data with an emphasis on the most recent price activity.

Of note is the 55.5 TD cycle (333 - 65 min bars) which had been reliable in the past but became less so after the crash in 2008.

A reversal is in the making.

For the first time in a couple of months we are starting to see bullish developments in the market indicators. The McClellan Oscillator and its components have finally made a rising lows pattern and are diverging bullishly from the SPX price which made lower lows. In addition, on the recent low, the 10% indicator held above the -500 threshold which is a necessary condition to establish a bottoming pattern. What I would like to see next would be a rise above +500 for the 10% Index as a confirmation that the market has enough power to establish a new leg up.

The McClellan Oscillator with a bullish divergence from price.
Click to enlarge.

The percentage of stocks above their moving average.
Click to enlarge.

Click to enlarge.

The VIX Perspective

The VIX (this is the old VIX, the VXO) provides some historical perspective on the fear factor in the markets, especially when viewed over varying timeframes. I do not expect the peaks reached in late 2009 to be revisited anytime in the near term.

Painful but constructive

While the possibility for a news driven crash like decline still exists, I'm inclined to think that barring any extreme new negative news, the markets are attempting to reverse at present levels. I've marked up the MCO chart with why I think this is the case.



Below is a set of SPX charts in different time frames. The lower low in the PPO (MACD) on the daily chart indicates that more time is required to complete the bottoming process. Typically this would occur as a lower price low accompanied by a higher low on the PPO ((MACD).

M2 - Money Supply

There's been some discussions about the "collapse" in the rate of growth of M3, the money supply. I question both the timing and accuracy of these speculations since M3 is no longer being used by the Federal Reserve. From the Federal Reserve press release on the cancellation of M3 data:

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. ...

M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits. Source

Below is an Excel chart made from the Federal Reserve data. The magenta line is the straight line continuous growth trend which appears curved on an arithmetic scaled chart. It is apparent that in the latter part of 2008 the rate of growth in M2 increased rapidly as liquidity was injected into the system because of the financial crisis. Over the last 18 months the rate of growth slowed towards the more normal rate. The data point on April 19th was the low spot and M2 has turned higher since then.

Turnaround Confirmed

The low in in. While the recent negative reading in the 10% Index of the MCO suggests the markets will need another retest of the low, it does not mean we have to revisit the low price zone, nor does it have to happen right away. A degree of caution remains prudent, as the markets are skittish and responding to negative news badly.

With the MCO approaching the zero line and the SPX approaching the 200 day average from below we could see a slight hesitation on Friday before the three day weekend.

Never the less, the zig-zag in the MCO is being confirmed by all the other market internals and the possibility for a very strong rally is very high. Adding to the technical picture, the sentiment indicators are wildly negative.

As of 5/26/2010, AAII members are:
Bullish: 29.82%
Neutral: 19.30%
Bearish: 50.88% <-- blood in the streets type fear.

At the Crossroads

Maybe today's reversal was the end of the decline. The McClellan Oscillator has moved in a small range for the last two days and this type of behavior usually precedes a strong move, one way or the other. That was what occurred today, unfortunately we started from a huge down gap before rallying. Whatever, change your underwear and get ready for some upside action, assuming of course that we're through crashing.

I still feel there is the need to complete a retest of the current low zone with the 10% component staying above the lower limit of -500, something which could occur within a week or get dragged out for a month. Once that is complete, the upward rally should continue to new recovery highs and confirm the bull market status. (i.e. higher lows and higher highs on the intermediate term)

Oops

We're in crash mode here. I'd expect a bounce on Friday because of the oversold condition, end of week shortcovering and option expiration. Other than that, I doubt the markets can generate a turn before late Monday or Tuesday.

Added @10:00 PM: While things look very scarey at the moment I suspect that the current declining phase is about over. The MCO is so oversold that we could see a strong rally tomorrow but this may depend more on the option market than anything else.
We can be sure that across the waters, bankers and politicians will be working over the weekend to find the right shade of lipstick. The markets are setup for a crash or a rally, I suspect they want the latter.

I've now added someother technical indicators for historical reference.

Set up for a bounce

Unfortunately the MCO 10% component brokedown indicating the current low zone requires a retest.

While it's possible we are at the start of a waterfall meltdown, I suspect this isn't the case. The MCO is extremely stretched out on the downside and this usually results in a vigorous bounce.

The breakdown in the 10% Index is more worrisome because this condition generally results in a retest of the lows before the trend upward is reestablished. What may lie ahead for the next 4-6 months is a range bound market until the fundamentals become clearer.

MCO Update

It turns out that the big spike down may have been the result of a 75,000 sale of EMini contracts by Waddell & Reed [AP story] Whatever, it completed the setup for the formation of a nice low at current market levels. It's allowable for a the markets to decline a bit more in the next few days but any excess of bullish sentiment has been erased and prices on individual issues seem to be firming. Never say never, but as long as the markets don't collapse from todays levels I believe a reversal is in process. A nasty close to the downside would invalidate my opinion but only to the degree that more time would be needed to complete the bottoming process.

The McClellan Oscillator and its Components
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Breadth and Sentiment Indicators
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EU show of support to stem Euro crisis.

GEE WIZ -- With the MCO lower than it was in March 2009 we conveniently have a show of force. Expect the market to rally on Monday. The markets will eventually try to retest last weeks decline but NOT the spike low.
From Bloomberg News:
"EU Crafts $962 Billion Show of Force to Halt Crisis"

By James G. Neuger and Meera Louis

May 10 (Bloomberg) -- European policy makers unveiled an unprecedented loan package worth nearly $1 trillion and a program of securities purchases as they spearheaded a drive to stop a sovereign-debt crisis that threatened to shatter confidence in the euro. Jolted into action by last week’s slide in the currency to a 14-month low and soaring bond yields in Portugal and Spain, governments of the 16 euro nations agreed to make loans of as much as 750 billion euros ($962 billion) available to countries under attack from speculators.

The ECB will also embark on “very significant operations,” European Union Economic and Monetary Commissioner Olli Rehn told reporters in Brussels after the 14-hour meeting. “The ECB has taken a decision to intervene in the secondary markets of government securities.”

Under pressure from the U.S. and Asia to stabilize markets, the European governments gambled that the show of financial force would prevent a sovereign-debt crisis and muffle speculation that the 11-year-old euro might break apart.

Europe’s failure to contain Greece’s fiscal crisis triggered a 4.1 percent drop in the euro last week, the biggest weekly decline since the aftermath of Lehman Brothers Holdings Inc.’s collapse. It prompted President Barack Obama to call German Chancellor Angela Merkel and French President Nicolas Sarkozy yesterday to urge “resolute steps” in Europe to prevent the crisis from cascading around the world.

Under the loan package, euro-area governments pledged to make 440 billion euros available, with 60 billion euros more from the EU’s budget and as much as 250 billion euros from the International Monetary Fund, said Spanish Economy Minister Elena Salgado.

“We are placing considerable sums in the interests of stability in Europe,” Salgado told reporters after chairing the meeting.

MCO Update

The market is in the midst of a mini panic in response to uncertainties over sovereign debt, primarily Greece. As of todays close the McClellan oscillator is very oversold and I would expect a bounce between tomorrow and Tuesday. Because of the seriousness of the decline it's likely the markets will need a week or two to rebuild confidence.

The McClellan Oscillator and its Components
Click to enlarge

MCO Update - Overbought but Bullish

The MCO's 10% Index spent the entire week above the +500 level indicating we are in the midst of a strong trending move in the market. While the indicators are overbought any decline is likely to be short lived with the trend drifting higher in a choppy fashion. In addition the upside breakout of the down trends established earlier in these indicators leads me to believe we could expect the general up trend to continue for at least a month or two more.

The McClellan Oscillator and its Components
Click to enlarge

Dragging out the low spot.

Looks like the pause will continue here for awhile longer. We are approaching the anniversary date of the March 2009 market lows and the resulting profit taking as investor gains become long term.

Weekly SPX with NYSE new highs and new lows.
Click to enlarge

The Correction Appears to be Ending

The US markets managed to reverse todays intraday losses and close on a positive note. While market breadth was negative with decliners outpacing advancing issues 2253 to 1584 it appears that the McClellan Oscillator has successfully completed a retest of last weeks low. Even though the last two trading days were fairly ugly from a price loss perspective, the 10% Index remained above the -500 warning threshold. While it's still possible for the markets to breakdown from here it does not appear that this will be the case as long as the 10% Index stays above the -500 level.

Todays MCO change was minimal at just +5.95. A small MCO change often proceeds a sharp move in the market within a few days. I expect a big rally Monday or Tuesday.
The McClellan Oscillator for Friday 2/5/10
Click to enlarge

MCO update

The markets had a solid run for the first two weeks of January and are taking a pause to refresh. There's a good chance the old 55 day trading cycle is coming back in force with a potential low date on Monday or Tuesday.

Fridays trading action saw an attempt to reverse the decline in the afternoon, the McClellan Oscillator intraday was near the -300 level, but the traders who jumped the gun anticipating a reversal were kicked in the groin late in the afternoon. Regardless, the MCO suggests we have a setup for a reversal Monday or Tuesday. Even though the MCO is in the oversold area at -243, the 5% component is still positive. This is typical of corrections in a bullish market.

At this point before I get more bullish, I'd like to see a little zig-zag in the MCO or a bounce and retest of its low with the 10% component holding above the -500 level. After a bit of fiddling around I expect the SPX to tack on another 15% and move higher into the 1250 zone.

The McClellan Oscillator for 1/22/10
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Historical Blogger Sentiment
Source: Ticker Sense
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