Stock markets: reversal time?

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I indicated in Sunday’s “Words from the Wise” review that “the speed and sheer magnitude of the rally argue for markets to either consolidate or retrace some of the past nine weeks’ gains prior to moving higher”.

Is the rally about to be reigned in? While most major stock market indices are encountering resistance at their 200-day moving averages and/or at the early January highs, a few other indicators also warrant our attention.

Two sectors that have been leading the overall market higher during the rally that commenced on March 9 – small caps and technology – have reversed their outperformance, as seen from the turnaround in the relative performance. The first chart plots the Nasdaq Composite index relative to the NY Composite Index, while the second compares the performance of the Russell 2000 Small Cap Index with that of the S&P 100 Index (large caps). A rising relative strength line indicates outperformance and a declining line underperformance.

12-mei-sm1.jpg

Source: StockCharts.com

12-mei-sm2.jpg

Source: StockCharts.com

I will keep a close eye on these two charts as relative weakness of small caps and technology will not be a good sign for an overall market that is overbought and looking exhausted after its monumental rally over the past nine weeks.

Another interesting-looking chart is that of the S&P 500 Index’s Bollinger Bands. Although a close below the 20-day moving average (dotted blue line) is required to confirm a correction, the fact that the price is touching the upper band indicates a short-term overbought condition. Also, the black line in the bottom section of the chart – measuring the width of the Bollinger bands – has turned up and is signaling expanding bands. This usually points to rising volatility and lower prices, similar to those experienced at the January and February lows.

12-mei-sm3.jpg

Source: StockCharts.com

For those who missed the item over the weekend on Adam Hewison’s (INO.com) technical analysis of the S&P 500’s most likely direction and important chart levels, click here to access the video presentation.

I still maintain that US and other mature stock markets are in the process of mapping out a base development formation which probably means toing and froing between policy tailwinds and economic headwinds. It is only natural (and necessary) that profit-taking should set in after the strong advance; a pullback should not be too much cause for concern, provided the levels from which the rally commenced on March 9 hold.

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10 comments to Stock markets: reversal time?

  • bill

    I m using the Mclellan Oscillator to measure short term breadth and change in sentiment on the NYSE., so far it s holding up in positive territory, no alarm bells yet.

  • SA Youngster

    Looks like the type of market traders will enjoy. Are these opportunities for longer-term investors as well?

  • Michael Williams

    John,

    How do you feel about publishing a “USA Citizen Investment Index” showing the value of the investments we’ve made in the banking/financial/automotive industries?

    Thanks.

  • Very good post with a great timing indeed!

    Sell in May and go away,

    Dax Speculator

  • FreeMarket Champion

    Michael – intriguing idea. However, may I suggest a slight tweak to “USA Citizen Confiscation and Redeployment Index”?

    Bill

    Michael Williams says:
    May 12th, 2009 at 2:09 pm

    John,

    How do you feel about publishing a “USA Citizen Investment Index” showing the value of the investments we’ve made in the banking/financial/automotive industries?

    Thanks.

  • pete kane

    Your last sentence means that we can go all the way back to March 9th lows and you will not be overly concerned?

    So we can drop 25% from here and no problem?

    really?

  • Peter: In my opinion, as long as the March 9 lows hold the new uptrend will remain intact, i.e. not mapping out lower lows. I’d be very surprized if the leading markets (like China and Brazil) decline as much, but it is possible that the lagging OECD markets (still in base formation development) retrace a larger chunk of the nine-week gains.

  • pete kane

    Merci, Prieur, for your reply, I appreciate it.

    I am way too nervous to stay in for that much of a decline, but I am (partly) in because “everyone” thinks this rally is almost over so since whatever everyone thinks is always wrong, here I am. I will get out as soon as most TV pundits tell me this rally is for real.

    Thanks again, I enjoy reading your posts!

  • bill

    FYI Mclellan Oscillator turned positive 13/3/09 around 730 level (for S&P) still running long at 900.

  • [...] more discussion about the direction of stock markets, also see my recent posts “Stock markets: Reversal time?“, “Technical talk: Nasdaq in correction mode” and “Video-o-rama: Gloomy [...]

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