October is living up to its reputation of being a spooky month. But in the midst of these “scary” times, please realize that the month of October also has a reputation for registering significant Lows. A Low is a function of price only, which ideally develops into a Bottom. In my opinion, equity market Bottoms are a function of both price and time via a Low-Rally-Retest sequence (W-pattern) that occurs over a period of time [week(s)-month(s)].

What Happened? In a word, the market indices themselves are playing catch-up on the downside. The internal correction had been in place for a few weeks and combined with a short-term overbought condition that turned into an external pullback last week (the market indices themselves declined). Yesterday, that internal correction accelerated. The NASDAQ (7422.05) and Russell 2000 (1575.41), downside leaders, closed below their rising 200-DMA support line. The S&P 500 (2785.68) and DJIA (25598.74) are within a “whisker or two” of their 200-DMA support line, currently at 2765 and 25,138 respectively. 

What Am I Following? To discern when market corrections/pullbacks may slow down, stabilize, or end, and with the beginning stage of a “W-pattern” close at hand, I like to analyze price (magnitude and intensity), time (duration) and emotion (sentiment).  

  • Price (magnitude and intensity):  

    • NYSE Down Volume to total NYSE Up and Down volume of 90% or greater = intense selling pressure. Yesterday’s reading was 91.5%. Additionally, NYSE Declining volume beat NYSE Advancing volume by a ratio of 10.7 to 1, also implying intense selling.

    • NYSE Total Volume was very high and far above its 50-day average.

    • Percent of stocks in NYSE, SPX and SML above 50-DMA and 200-DMA are at or close to levels seen in February-March = oversold/almost oversold.

    • The Russell 2000 and the NASDAQ (semis and internet stocks) lead the decline. They may be a helpful guidepost to show when the selling has run its course and a rally attempt begins.  

  • Time (duration): While the Large Cap market indices have only been pulling back for a little over a week, internal readings have been declining for a few weeks, and the RUT has been pulling back for close to six weeks. All to say, as before, Bottoms are a function of price and time as a Low-Rally-Retest sequence (W-pattern) occurs over a period of week(s) to month(s), in my opinion.

  • Emotion (sentiment): The 5-day Total Put/Call ratio closed at 1.12, near the 1.15 level used to discern when optimism is converting to pessimism. Also, the NDR Daily Trading Sentiment Composite has fallen into the extreme pessimism zone. Historically, this has been good for the market. A spike by the Volatility Index, above 20-25+, is also an indication of emotional selling. The VIX closed yesterday at 22.96.

Final Thoughts: I am now watching for the establishment of a Low, which may be close at hand. However, rallies need to be broad and strong, not narrow. Ideally, buying intensity shows up in the form of a Breadth Thrust, the NYSE Up Volume to total NYSE Up and Down volume being 90% or greater, or the NYSE Advancing volume beating NYSE Declining volume by a ratio of 10 to 1. Until this occurs, please be prudent and don’t let your emotions get the better of you!

  • Value possesses mean reversion potential. (Ned Davis Research)

  • Value has tended to outperform during interest-rate market backups, in part because Financials represent the largest sector weighting in the S&P 500 Value Index. That sector has a positive correlation to rates and the curve over the past couple of years. (J.P. Morgan)

Chart Review:

Value   has tended to outperform during interest-rate market backups, in part because Financials represent the largest sector weighting in the S&P 500 Value Index. That sector has a positive correlation to rates and the curve over the past couple of years. (J.P. Morgan)

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Art Huprich, CMT
Chief Market Technician
Day Hagan Asset Management

—Written 10.10.2018. Chart sources: Stockcharts.

PDF Copy of Article: Day Hagan Tech Talk October 11, 2018 (pdf)

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