Monday, August 06, 2007

The Dow Follows-through

Now that Spector has resigned as head of Bear Stearns -- and a scapegoat is safely in place -- we can all get back to buying stocks.

At least that's what the market appeared to be saying on Monday.

In an interesting development, Day 4 of last week's rally attempt saw the Dow print an IBD follow-through day. Despite Friday's selloff, the Dow never undercut last week's low, and that kept the rally attempt alive. On Monday, the Dow surged 2.2% on a 1% uptick in volume and the bull "officially" lives on. Of course, Barry Bonds is about to "officially" break Hank Aaron's record also.

According to the steroid-free research of Bill O'Neil, market rallies are confirmed by a follow-through day on one or more indexes. While it doesn't guarantee success, it shifts pressure back to the bears to maintain control of the pullback. In short, the bulls now have a slight, statistical advantage, but how long it lasts is anyone's guess.

The NDX hasn't cut through last Wednesday's low either, but its 1.9% bounceback came on slightly lower trade (0.6% lower to be exact). Since the market peaked in July, Industrials and Technology are two sectors that have held up well, and their strength was visible again on Monday. Below are both the Dow and the NDX.

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One of the problems in identifying the bottom as it occurs is that powerful divergences usually arrive to blur the signal. For example, stocks enjoyed a powerful reversal on Monday, but NASDAQ breadth was still negative. Even worse, New Lows totally spanked New Highs, 1171-102. This is a ratio of 11-to-1, which may be signaling a climax bottom -- or not. This statistic is also consistent with dead cat bounces, and in the context of a bounce day is worthy of caution.

Leading stocks certainly didn't clear anything up. The IBD100 trailed the broader market with a 0.5% gain, and 28 stocks saw distribution, vs. just 21 that saw accumulation. Definitely a mixed picture from the market leadership, although this too is very characteristic of market bottoms. Regardless, you want to see a proxy for stocks with the very best fundamentals to show accumulation if a real bottom is in place.

The chart below shows that the NASDAQ put in a beauty at it's 200-day on a 9% surge in volume. This is an ideal reaction at support, but it's also nothing more than Day 1 of a new rally attempt. It's still a nasty-looking chart with a lot of work to do.

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On Monday, new NASDAQ lows spiked higher than even at the 2002 bottom -- and this is definitely odd for an 8.5% pullback. Still, Monday's New Low total just barely squeaked into the top 7 in the past 7 years, so it has room to get much worse.

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The Financials saw genuine buying for the first time in two months, and the surge erased 3 1/2 days of weirdness in one, fell swoop. This is a difficult group to have confidence in, as the odds of roaches in the walls are still very high. The Death Cross doesn't help either.

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Another group flashing weirdness is energy. Energy stocks and the underlying commodity have been out of sync for three weeks. As XLE pulled back 12%, crude kept climbing another 14%. Today crude fell to its 50-day, while the XLE reversed at its 200-day. This asynchronous volatility is not for the feint of heart.

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If the market climbs higher, retests, and this proves to be "the" bottom, the bulls have serious mojo. Based on investor sentiment numbers, they also deserve a great deal more respect than most investors are giving them.

Thus far, the ratio of hissy-fits to price declines is one for the record book. For the "worst fixed income market in 22 years" to produce a sub-10% stock market decline would suggest we're in an unusually powerful bull market with room to run.

Of course, step one is that the bottom has to hold, and with the VIX printing a 22-handle, there are definitely more challenges ahead.

Until then, see you tomorrow.




Chris said...

I must say, this is an excellent post as well. We'll see what happens in the coming weeks. My data suggests so many different outcomes; it is crazy!

Woodshedder said...

Great post!