If you recall we had said that low volume rallies while showing a lack of demand, which is longer-term bearish, can last far longer than one would expect. When volume does increase the longer the rally or fro that matter decline has gone on low volume the more potential risk we run that this increased volume is a blow off or capitulation rather than a confirmation. The breakout in early October by the S&P above its September high was accompanied by a sharp rise in volume. We had at the time viewed that volume expansion as a bullish confirmation of the price breakout. However, that turned out to be completely wrong as it instead looked to be a mini blow off in volume as well as a confirmed false breakout as the S&P has subsequently taken back all of those gains and nearly all of the post September 28 gains as well. The decline from the October 6 high has been accompanied by expanding volume or if not expanding than near what we had seen in late September-early October.
When volume is high at the beginning of a move, whether that move is to the upside or downside that is a sign of confirmation and can signal a change in trend. Take a look at the volume coming off the March 2003 low or for that matter the October 2002 low. The fact that volume has been relatively high as the market turned down in early October suggests confirmation of a change in trend even if only short-term. It is certainly not consistent with a consolidation such as many or postulating currently. This does not mean it is not but it is not consistent with what we have seen over the years and argues against that outcome.
Last time we discussed a number of potential divergences that had been building in a number of our important momentum indicators. Those divergences, every one of them were confirmed as real with the markets decline following the October 6 peak. These indicators, including the McClellan oscillator have all confirmed price at last weeks low and did so from levels that in most cases are followed by lower prices. this does not preclude a bounce or even a minor rally interlude first. The daily trend indicators are giving off the same signal arguing for lower prices. In addition, the daily trend indicators gave an added negative signal as they turned positive late following the September 21 low and left a big divergence in place with its September 21 peak. While it does not look as bad as it did in June it does look strikingly similar to the pattern in early August. The bottom line is that most all of our momentum indicators have confirmed price and point to further weakness at least on a short-term basis.
We also discussed last time the multiple divergences between the DJIA and the S&P dating back to their last joint high of the post August rally on September 7. The divergences continued right into October 6, both with the September 6 peak as well as with October 4 as the S&P was able to beat its October 4 high while the DJIA failed. The decline last week saw the DJIA move below its September 28 low and come within 1% of its August low. The S&P was able to hold above its September 28 low by less than a point and is far from its August low. This sets up a potential divergence between these two averages that if confirmed would be a bullish divergence. Before we rush off to declare a buy signal lets not lose sight of the fact that this is far from confirmed and more importantly will take some time to confirm. Keep in mind it took nearly a full month from September 7 to October 6 to confirm the negative divergences between these to averages.
A majority of our sentiment indicators have weakened during the rally. The most negative remains the continued high level of insider selling. The sentiment polls such as Investors Intelligence and AAII have also slipped and are borderline bearish. However, neither one of these polls are close to where they stood at the June peak. This does not mean that the market cannot embark on a medium-term decline right now. Keep in mind that sentiment is considerably more difficult to quantify than momentum, not that momentum is that easy either. Momentum, moreover, will win out over sentiment more times than not. A prime example of this was seen last year as the market, in spite of facing sentiment that in a number of cases was more negative than at the 2000 top, just kept on rallying and rallying.
However, the market has been in a trading range most of this year and these indicators have been quite consistent at both the April and June tops as well as the May and August lows. And what we have seen at the October high is not consistent with what we saw in March, April or June. Again, this does not mean that this is the correct approach currently but its consistency this year so far at least does suggest we pay attention to it until proven wrong.
OK, so what does this all mean for investors and traders?. Our view at the August low was that we saw very little to suggest that the ensuing rally was of any greater import than what we saw unfold from mid May to late June. This has been borne out so far and is supported by what us clearly a corrective pattern from the wave structure. At the same time, the rally has not generated the same type of acceptance seen at previous tops this year. The similarities in the charts of some important momentum measures currently and back in late June does give one pause for consideration that perhaps there is more to this top than we see at this time but this would need to be confirmed by a break of important Fibonacci support and also by price structure. To that end we would need to see a clean five-wave decline on the daily chart while also moving convincingly below 1085. We remain bearish short-term with a stop of 1121 on the S&P. Medium-term we are neutral and long-term we remain bearish.
Regards,
Larry Katz
