September 17th, 2009

Signposts of a Correction

Regular readers remember the market breadth indicators that frequently appeared here as we attempted to gauge the internal strength of the bottom reversal the market was forming. It doesn’t hurt to report on those indicators now that a bull market has clearly developed and the Fed Chairman has declared the recession as being over:

The numbers bear the recovery out. Less than a month ago, at the end of August when the Index was 1020, only 51 stocks were making new highs; today, with the Index 4.7% higher, there were 313 new one-year highs. The number of Bull Crosses (where the closing price is higher than all the moving averages and all the MAs are aligned from fastest to slowest) has almost doubled to 479, or nearly 10% of the stocks in my database.

I went to an MTA (Market Technicians Association) meeting earlier this week and the excellent speaker, John Roque of WJB Capital Group, started off by asking for a show of hands among the 100 attendees as to where they thought we were on a chart similar to the cycle if market emotions that I presented here in “From Shoulder to Bump, Hopefully” of May 29:

You would expect that in a roomful of technical analysts and traders there would be concurrence as to what stage the market was in. About half thought we were at Hope and Relief, a third that we were at Thrill and Euphoria; a handful though the market was in Despondency and Depression. I don’t know where you think the market is but, in my opinion we’re somewhere between Optimism and Excitement. Yes, the best is yet to come.

All these divergent opinions is what makes a market. For every buyer there needs to be a seller. The only thing that truly matters is whether the buyers’ demand overwhelms the desire of sellers to sell and which trend, the power of demand or weight of supply is accelerating the most.

As an aside, I often read Elliott Wave material just to see a different perspective. The recent EW material claims now “the rally is waning. A downside reversal is imminent.” Elsewhere, they shout “The Bear Market’s Most Violent Decline Right Around the Corner? Meet Wave 3: The Superhero of All Waves”. And what is a Wave 3? “There’s no mistaking wave 3’s characteristics:

  • It gets to where it’s going in a hurry.
  • It usually catches everyone by surprise, and
  • You’ll know it when you see it.”

I’ve never been very good at Wave counting and find it inconsistent and conflicting (sorry all you EW’ers out there). I need more concrete ways of measuring the market’s health. It would be irresponsible to let your guard down in the belief that what’s been a truly terrific market can extrapolate out indefinitely into the future. There will be a correction (even if it isn’t the catastrophic collapse the EW’ers yearn for). Every coin has two sides and while we’ve measured market breadth for a bull, so we begin here measuring market erosion for a possible correction.

Interesting, but insufficient for making any sort of determination. But I’ll continue updating the stats which, along with other measures will alert us if and when an over-extended market is entering a correction.