INTERNAL CORRECTION TURNS INTO AN EXTERNAL PULLBACK
In my last Tech Talk report dated 10/1/18, I discussed one of the benefits that technical analysis brings to the investment process. Specifically, while technical analysis doesn’t always immediately provide the answer, many times it forces you to think and start asking pertinent questions. Another value of technical analysis, when it comes to examining the strength or not of the equity market, is that, instead of relying on someone’s opinion, it more times than not reflects what is actually happening now relative to buying and selling pressure.
After hitting a new high early last week, the S&P 500 Index (SPX/2884.43) itself finally succumbed to the internal selling pressure that I previously noted within the Small Cap complex. When combined with an overbought condition (Tech Talk report dated 9/25/18), the SPX ended up pulling back 1% at week’s end. At the same time, the NASDAQ 100 (NDX/7352.82) and Russell 2000 (RUT/1629.52) were off almost 4% last week. At the time of this writing, the SPX is still above its 50-DMA, currently at 2878.45 (this will change each day). However, only 49% of stocks in the index are above their 50-DMAs. This means that the individual stocks that make up the index are weaker than the index itself—a minor, negative breadth divergence, but a breadth divergence nonetheless. Speaking of “50-DMAs” the NDX closed below its 50-DMA last week. This broke a streak of more than 100 trading days above that moving average. According to Bespoke Investment Group, “Breaks of the 50-day in the past after long streaks above it for the NASDAQ 100 have been followed by further weakness over the near term… History has shown that you don’t want to jump back in on the long side right away.” Give things time to settle down and rebuild a new underlying base of support, ideally through a W pattern.
What should we be following now?
1) Russell 2000 is retesting its 200-DMA—chart below. In light of the weak/weakening relative strength trend that this index has been exhibiting since June, this is an important test for Small Cap stocks, and possibly the rest of the equity market.
2) How do Small Caps specifically, and Large Cap generally, respond to an oversold condition—chart below. Also, what is the quality of the next rally? Is the next rally broad and strong, or narrow and weak?
3) The SPX’s decline last week fits into the rising trend of the past six and a half months, with the lower end of that trend being around 2850, part of an important tactical range of support between 2864 and 2850. Additional support levels are highlighted in green—chart below.
4) Some type of spike in bearish sentiment and/or price volatility—VIX reading above 20 to 25+.
Summary: Until we get answers to at least a few of the points above, the technical underpinnings of the equity markets suggest near-term caution, within the context that the secular Bull market is still the dominant trend.
Primary oversold levels (solid green lines) or secondary oversold levels (dashed green lines) are being, or have been, approached. This implies some type of oversold condition, and an approaching rally try. However, the quality of the next rally attempt, in terms of breadth and strength, will be an important near-term guidepost.
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Art Huprich, CMT
Chief Market Technician
Day Hagan Asset Management
—Written 10.08.2018. Chart sources: Stockcharts.
PDF Copy of Article: Day Hagan Tech Talk October 9, 2018 (pdf)
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