There are any number of periods during the year that lend themselves to distortions of the indicators. Most of those periods center around holidays or pre holiday trading and on occasion options expiration. Our approach to those periods is to basically ignore the potential distortions. For one thing, we have never been able to figure out how much if any of the activity is due to distortions. Secondly, and in our view more importantly, these distortions tend to correct themselves on a day or two or even less. This is true because the distortions are usually due to one or maybe two days tops worth of trading. In some cases, such as options expirations it is only a few hours. The one time of year that this is not the case has just passed. That is because it is not just one or maybe two days of distortions but a week and perhaps longer if we take into account the pre Christmas slowdown as well.
The last week in particular causes a lot of problems with volume based indicators including straight volume measures such as the McClellan volume oscillator as well as such indicators as the Arms that have volume as a component .End of year tax strategies, portfolio adjustments also figure into the mix. These often have an affect on some of the short-term sentiment indicators such as the put to call ratios and the Rydex assets as these are used for hedging at times. In addition, the lack of liquidity as measured by the lower volume also can have an affect in the price. This can be be seen by either exaggerated price movement or lack there of. We just saw that last week as last three days of the year saw very little price movement and at times the market looked as though it was running in place. This is the one time of year that we make allowances for seasonal distortions and in fact recognize their affect on price and the indicators. For what its worth, we find this period to be the most difficult period of the year form a technical analysis perspective and we give a lot more latitude in assessing the message from the indicators while also recognizing it may take more than a day to get the market back "in gear"
With that behind us, we do think that we will get a more lucid picture of the market early this coming week. In looking at the indicators and the price structure over the past few weeks without accounting for the seasonal period we would have to be quite disappointed from a bullish perspective. Sentiment, other than the put to call ratios is running to excessive levels not seen since early last year. And even within the put to call ratios it is only the total CBOE ratio that has been rising The equity ratio although moving up a bit remains closer to its recent low and while not as excessive as it was in January last year it is right where it stood in early March. The polls are showing excessive bullish expectations, which has pushed the sentiment combo to its highest level since February and not far from challenging its all time bearish reading in late January of last year. Insiders have not eased one iota in their selling and the 8-week moving average is at its worst level since late March of last year. Keep in mind that this indicator hit its most negative reading in its 33 year history last November and it is not far from that level now.
As bad as the sentiment picture is we have to keep reminding ourselves that in our own words, what may look extreme can become even more extreme. This is very true in the latter phases of a blow off such as late 1999-2000 or in periods of strong no make that exceptional momentum. This was the case in the spring and summer of 2003 all the way up into early 2004. To this end, we did get a momentum surge both in early September and in early November. The market since the early November momentum peak has acted in what is best described as text-book fashion following the initial correction of the overbought condition as it continued to move higher. We are now facing the first set of negative divergences in momentum from the early November peak.
Some of these divergences are quite dramatic. This is the case with both the McClellan oscillator and the McClellan volume oscillator. They have both been in a fairly tight range since mid December after recovering from their first oversold reading in early December. The McClellan oscillator has had two moves since December 15 below zero since the December 15 peak and two mediocre moves back above zero but without any sign of even short-term strength. In fact, it looks like it was dragged reluctantly higher by the seasonally strong breadth period. Thirteen day RSI, which hit its highest overbought reading since January of 2004, also in early November has also been diverging since. It, (RSI) has been in a tightly wound range of lower highs and higher lows since mid December. We are also seeing what continues to be a very bearish pattern from the daily trend oscillators, which have gone flat and are also diverging.
What is interesting is that we are seeing a number of divergences from both internal momentum measures as well as priced based momentum indicators. The combination of negative bordering on excessive sentiment along with massive momentum divergences is historically a very negative one. It is a combination that in most cases would lead to a fairly big short and possibly medium-term decline. The one thing that is missing is confirmation from price. From that end we lo9ok to be closer is it appears that the S&P did slightly break down from a rising wedge formation on Friday. The problem here is that the breakdown occurred on light volume and in a seasonal period that is known for its false moves and distortions. We also see a number of signs that a big move short-term is brewing. We have seen two or three minor range days in the S&P last week, an inside day last Tuesday on the S&P and on Wednesday and Thursday on the DJIA as well as a minor net change day on Wednesday from the McClellan oscillator. We think that this will resolve itself in very short order and what we se early this month could set the stage for the month as a whole. That said, the ingredients are in place now for the first real price correction since the October low. A move lower in price early this week would, in all likelihood give us the confirmation from price that is so far lacking. We are going to remain neutral short-term but we need to be alter and ready to go with the market. Medium-term we are neutral but with a modestly positive bias and long-term we remain bearish.
Larry Katz
email me at: lk1618@comcast.net
website link: www.marketsummaryandforecast.com
Larry Katz serves as both editor and research director of Market Summary and Forecast. Mr. Katz is a full member in the Market Technicians Association and is both one of the founders and the president of their Southern California Chapter. He also serves on the management committee chairing the membership committee. Mr. Katz is a regular contributor to Top advisors corner on America On Line. He is a regular guest on the Business Channel in Los Angeles with Richard Saxton. He has been a quest speaker of the Market Analysts of Southern California (MASC), the Omega users group of Thousand Oaks, Ca. and Orange County, the Market Technicians Association Atlanta Chapter as well as the Foundation for the Study of Cycles. He also ran a workshop at the Market Technicians Association 1999 Annual Seminar. He has been a regular commentator on the Reuters Financial network, both in the US as well as in Japan, as well as being published in the Market Watch section of Barrons Magazine on a number of occasions. He is currently ranked in the top five for intermediate term gold timing by Timer Digest.
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