OVERWEIGHT STATISTICAL PROBABILITY, UNDERWEIGHT EMOTION

 

Due to travel, it’s been some time since I offered my thoughts. Three weeks ago, I stated that the market was

Fragmented; disorganized… within the context of an uptrend that supports equities… the probabilities suggest a short-term consolidation or pullback in the equity market… an ordinary correction can still appear at any time… be ready for it… implement an investment strategy that manages risk and is supported by an unemotional process.

If asked at the time, I would have said a pause/pullback of between 1% and 3%, maybe 5%, wouldn’t be surprising. However, despite the recent hysterics surrounding trade tariffs and boycotts, I felt the odds were low that we would experience an intraday decline of over 700 points by the DJIA or an almost 3.6% intraday decline by the NASDAQ. Both occurred as I wrote this update. Yesterday’s (5/13/2019) intraday price lows left the SPX (2811.87), DJIA (25324.99) and NASDAQ (7607.42) down roughly 5.4%, 5.7% and 7% respectively from their intraday price peaks of only two to three weeks ago. An adage on Wall Street says “the market goes up like an escalator and down like an elevator.” In other words, due to fear, market indexes go down a lot faster than they go up. Oh, yes!

Our models, in which we overweight statistical probability and underweight emotion, suggested at the beginning of May taking a fairly defensive cash/fixed income position, in the vicinity of 25%. We invest and will continue to invest as our models dictate.    

 What I See:

  • Sentiment indicators: Not all are at extreme levels, but they are moving in the right direction. The 5-day average of the CBOE Total Put/Call Ratio closed at 1.09 (109%). A reversal down from the 1.15 level (115%) or above (1.20 is ideal), would be viewed as a near-term positive—chart below. Also, the Ned Davis Daily Trading Sentiment Composite has moved down to levels depicting “extreme pessimism.” Following a move down to these levels, a reversal up would be viewed favorably—please don’t anticipate a reversal.    

  • Selling intensity and oversold levels: Declining volume on the NYSE yesterday was almost 91% of total Advancing and Declining volume. Also, the 10-day average of the Arms Index (a measure of selling and buying intensity) for the NYSE closed at 1.34 yesterday. A reversal down from this level would be viewed as a near-term positive, because many times intense selling signifies the end of a pullback.

    • Following intense selling an important guidepost is for this type of selling to be quickly followed by strong demand, or buying intensity (defined below). If buying intensity doesn’t quickly show up, the necessary oversold levels shown in the chart below (percentage of stocks above their 20-Day EMA—exponential moving average) will likely be reached.

  •  Support: As shown in the chart below, the S&P 500 has moved down to the upper end of a layer of support between 2800 and 2775 (200-DMA—not shown on chart). This is followed by another range of support between 2747 and 2722—small green circle.  

    • Point of reference: If “official” oversold levels and extreme pessimism levels (please refer to charts below) don’t quickly produce strong buying intensity and/or a sustainable rally, a 50% retracement of the advance realized by the S&P 500 from the December 2018 low to the May 2019 peak and a 10% correction from the May 2019 peak equate to approximately 2650.    

  •  Stock market volatility: This is likely to continue due to a combination of trade tiffs/tweets, geopolitical concerns, high-frequency and algorithmic trading, no uptick rule, etc.  

What do I need to see to conclude the pullback has run its course? 

  • Buying intensity (as discussed above): Two consecutive trading sessions when NYSE Advancing volume is 80% of total Advancing and Declining volume or one trading session when NYSE Advancing volume is 90% of total Advancing and Declining volume would, in this case, define “buying intensity”/strong demand. One of these sequences would imply that “prices” have declined enough to interest buyers again and will allow the current uptrend to continue. However, a rally that exhibits weak or lukewarm demand would suggest that the odds favor further downside probing.

S&P 500 5-Day Average of the CBOE Total Put/Call Ratio. Over the past few years, a reversal down from 1.15% or above has produced a strong rally, for the most part.

Oversold levels (tactical lows) are close but have not yet been reached.

Percent SPX Stocks Above 20-Day EMA (exponential moving average).
S&P 500 Large Cap Index. 2650 represent an approximate 10% correction from the May 2019 peak, and a 50% retracement of the rally between late December 2018 and May 2019.

UPCOMING EVENTS

Day Hagan Market Update Webinar with Donald Hagan, CFA, May 15, 2019 @ 4:15 PM EST

Day Hagan Technical Analysis Webinar with Art Huprich, CMT, May 21, 2019 @ 4:15 PM EST

Art Huprich, CMT
Chief Market Technician
Day Hagan Asset Management

— Written intraday and after the close, 05.13.2019. Chart sources: StockCharts.    

PDF Copy of Article: Day Hagan Tech Talk May 14, 2019 (PDF)

Disclosure: The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management (DHAM), any of its affiliates or employees, or any third-party data provider, shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. DHAM accounts that DHAM or its affiliated companies manage, or their respective shareholders, directors, officers and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.

Investment advisory services offered through Day Hagan Asset Management, an SEC registered investment advisory firm. Accounts held at Raymond James and Associates, Inc. (member NYSE, SIPC). None of the entities listed here in this disclosure are affiliated.