StockCharts Blogs - ChartWatchers

POOR SENTIMENT, MAX PAIN AND THE BOWLEY TREND

Tuesday afternoon marked a short-term bottom. In my opinion, we're going to print AT LEAST one more low in time; however, the sentiment had deteriorated on Tuesday to a point where we normally we see a rebound. In addition, there was TONS of net put premium (in-the-money put premium minus in-the-money call premium) and options were set to expire on Friday. We'll discuss sentiment issues shortly, but first take a look at the following closing prices on ETFs as of Tuesday and their respective max pain (the price point at which the premium on in-the-money call options equals the premium on in-the-money put options) prices:

DIA - closed on Tuesday at 109.30 and max pain was near 114.
SPY - closed on Tuesday at 120.99 and max pain was near 128.
QQQQ - closed on Tuesday at 44.24 and max pain was near 48.
XLF - closed on Tuesday at 17.17 and max pain was near 21.

I calculated the value of the net put premium on the QQQQ as of Tuesday and determined it to be approximately $250 million! That's just for one ETF. Imagine the amount of net put premium across all stock, ETF and index options. If the QQQQ's had continued to decline, the net put premium would have risen exponentially. In addition, there were over 1.825 million put option contracts traded on Tuesday, a record since the CBOE has been providing the equity only put call data. Simply put, the bears were a greedy bunch and the rubber band was stretched about as far as it was going to go near-term. As a result, there was a wicked rally on Wednesday and Thursday as prices gravitated much closer to max pain points. The max pain is a figure I calculate every month and it provides yet one more clue as to how the market might react near-term. This time, it was dead on.

Now back to sentiment. The equity put call ratio finished on Tuesday at .90 and the 5 day moving average of the equity only put call ratio had spiked to .88, the highest level since March 24th. In addition, the VIX spiked above 30. Readings above 30 on the VIX have coincided with recent market bottoms. In my last article, I discussed the lack of poor sentiment readings and indicated that we needed to see a step up in fear. We finally saw that on Tuesday. Now for the bad news. It wasn't fearful enough. The market was already primed to rebound off of oversold conditions, max pain issues and even a few recent positive divergences on intraday charts. That rebound materialized on Wednesday and Thursday. Take a look at Chart 1 below to review the VIX:

The resistance area on the VIX is above 35 - we have plenty of room to ramp up fear. The current uptrend may take us to that level before it breaks. Time will tell. Separately, while the put call ratio has been on the move to the upside and reflecting increased pessimism, it too has more room to go. Check out Chart 2:

While we mentioned earlier that the "equity only" put call ratio approached the March fear levels, the total put call ratio as reflected in the above chart did not.

Historically, we entered on Friday the 2nd worst time period of the year. At Invested Central, we provide a historical perspective ("The Bowley Trend") on each trading day. For instance, consider the following data that relates to trading on the S&P 500 since 1950:

On July 18th, the S&P 500 has advanced 13 times, declined 29 times and has produced an annualized return of -46.48%
July 19th - 19 up days, 22 down days, -16.15%
July 20th - 19 up days, 23 down days, -20.76%
July 21st - 16 up days, 24 down days, -46.18%
July 22nd - 17 up days, 23 down days, -49.24%
July 23rd - 19 up days, 22 down days, -57.19%

Now for the NASDAQ since 1971:

July 18th - 9 up, 18 down, -91.68%
July 19th - 15 up, 13 down, -52.32%
July 20th - 14 up, 13 down, -17.81%
July 21st - 10 up, 16 down, -83.59%
July 22nd - 11 up, 14 down, -71.33%
July 23rd - 12 up, 13 down, -158.68%
July 24th - 12 up, 14 down, +1.49%

If the market advances over the next week, it will be doing it against significant historical headwinds.

Happy trading!

Join Tom and the Invested Central team at www.investedcentral.com. Invested Central provides daily market guidance, intraday stock alerts, annotated stock setups, LIVE member chat sessions, and much, much more.

BAD NEWS FOR BONDS

After the Producer Price Index (PPI) surged on Tuesday, it was little surprise to see big gains in the Consumer Price Index (CPI) on Wednesday. Bernanke warned of inflation in his congressional testimony last week and the PPI-CPI figures confirm. The CPI surged 5% year-on-year and 1.1% month-on-month. That 1.1% monthly gain translates into an annual rate much higher than 5%. The 5% year-on-year change was the highest since 1991, while the 1.1% month-on-month change was the highest since 1982. For the sake of argument, let's take the 5% year-on-year change as the annual inflation rate. The 10-Year Note Yield ($TNX) is currently around 4.08%, which means the real yield is actually negative (4.08% less 5% equals -.92%). A negative real yield is bad news for bonds. The first chart below shows the 10-Year Note Yield ($TNX) breaking resistance from its February highs with a surge above 4% (40). TNX pulled back over the last few weeks, but found support around 3.8% (38) and moved higher this week. The second chart shows the iShares 20+ Year Bond ETF (TLT) hitting resistance after retracing 50-62% of the March-June decline. The ETF gapped down on Wednesday as investors reacted to the news on inflation and the negative real yield.

There is also a videoversion of the this analysis available at TDTrader.com - Click Here.

DISASTER AVERTED, SO FAR

In my July 3 article I warned that the market was oversold, dangerous, and vulnerable to a crash. On Tuesday of this week, the S&P 500 opened down, breaking significant support, and kept moving lower. I thought to myself, "This is it. Crash in progress." Then subtle buying began, the decline was stopped in its tracks, and an advance began that lasted three days. My sense of the events was that the Crash Prevention Team had acted, but that is pure speculation about an urban myth. Certainly there were fundamental events later in the week that assisted the rally -- the president's lifting the executive prohibition of off-shore drilling, and oil prices dropping to $130 -- but the price reversal during the first hour on Tuesday seemed magical to say the least.

At this point the advance has hit the overhead resistance of a declining tops line. If that is decisively penetrated, I would conclude that the rally will continue, although, there is another declining tops line dead ahead.

While the volume for the rally has been convincing, and medium-term indicators are very oversold, I am not so impressed with two key short-term indicators shown on the next chart. The Climactic Volume Indicator (CVI) and the UP Participation Index (PI) are where I look for evidence of an initiation climax, which would confirm that an advance is receiving broad participation from both volume and price. (An initiation climax demonstrates that the initial surge of the rally has sufficient internal strength to support and extend an apparent price reversal.) So far the CVI and PI levels are far short of the overbought levels needed to reflect that an initiation climax has occurred; although, this deficiency could be remedied next week. At any rate, I recommend keeping an eye on these indicators as (if) the rally continues.

Bottom Line: A crash was averted this week, and the potential for a new medium-term rally has developed. There are plenty of reasons to believe in this rally, but be advised that important short-term evidence has not yet materialized. If prices head back down for a retest, the danger meter will be redlined. If the rally does indeed continue, there will be wide-spread belief that the bear market is over. In my opinion, that conclusion will eventually be proved wrong. Participation in the rally, if it develops, should be managed on a short-term basis and on the assumption that it is only a bear market rally.

RALLY FORTHCOMING IN HOUSING MARKET?

Last week may very well have been an important turning point in the US stock market, with the Dow Industrials and the Russell 2000 Small Caps as forming bullish "key reversal" patterns to the upside. This would suggest an increased probability of further strength on the order of several weeks or perhaps even months; however, we would caution that the probability of such a rally isn't as high as it would be normally given the weak advance/decline figures as well as the up/down volume figures - hence we believe it will be nothing more than a countertrend rally apt to fail. We'd like to have seen stronger advance/decline figures to provide some clarity to these bullish formations, but they simply weren't sufficient for our liking.

Be that as it may, we want to bring collective attention to the Housing Index ($HGX), which did manage to form a bullish "key reversal" accompanied by high volume. This would further suggest a rally of some magnitude is forthcoming; but once again we'll not put as high a probability of it developing as we would have if the broader market had printed stronger advance/decline figures. In any case, we wouldn't be surprised to see mean reversion higher materialize towards the declining 50-week exponential moving average at 145.

Therefore, we would use any declines in either Ryland Homes (RYL) or Toll Bros. (TOL) to put on a long position. We chose those two given they have performed relatively better than the Housing Index, which clearly broke its January lows. RYL and TOL did not; and if we are going to be long, then we want to be long that which is showing relative strength. As for risk...one can risk a break of the recent lows.

Good luck and good trading, Richard Rhodes

Want more of Richard's award-winning advice? Check out his Web site: Rhodes-Capital.com

SHORT-TERM SELL SIGNALS GIVEN

This week's downturn in crude oil prices has had a depressing effect on the entire commodity group. Chart 1 shows the CRB Index (plotted through Thursday) breaking a three-month up trendline (and its 50-day moving average). The 12-day Rate of Change (ROC) line (top of chart) has fallen to the lowest level in more than three months. And the daily MACD lines (bottom of chart) have turned negative after forming a "double top" between March and July. The minimum downside target is most likely a test of the 400 level which would test a yearlong support line and the early May low. I wouldn't, however, rule out a further drop to the March low at 380. The weekly CRB chart also suggests a very over-extended market in need of a correction.

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PINNING DOWN YOUR ANNOTATIONS

IMPORTANT NOTE: On August 1st, we are raising our subscription prices across the board by $5 per month. You can delay the impact of this price increase by renewing your account before the end of July. By renewing now you will also be able to take advantage of our Summer Special which gives long-term subscribers an additional month of service for free. Please see our previous newsletter for more details. Don't wait until it is too late - renew now!

Hello Fellow ChartWatchers!

This week I wanted to tell you about a new feature we've just rolled out in our ChartNotes chart annotation tool. It is called "pinning" and it allows you to prevent any of your saved annotations from scrolling to the left over time.

Normally, you want your annotations to scroll to the left because that is what the price bars do. As the price bars move, you want your trendlines and arrows and other annotations to move with them. However, there are certain kinds of annotations that you might not want to move - particularly "High Level" text comments, i.e., comments that describe what the chart is showing, not a specific feature of the current chart. Consider the following example:

On this chart the blue trendline, the red arrow and the text comment about the trendline break are all directly associated with the price action and we want them to move left with the price bars over time. In other words, we want those annotations to be "unpinned" (which is how things have always worked).

The other annotations at the top of the chart are different. The text that describes the chart and the box that surrounds that text are not directly associated with the current price action and we don't want that text to move over time. To prevent that text from moving, we can now "pin" that text so that it stays put. Text, callout boxes, boxes and circles are now "pinnable" annotations.

To pin an annotation, first click on it with the Selection tool, then click on the blue "pin" icon that appears on the lower left side of the ChartNotes window (see the picture above). That's all there is to it!

Hopefully, you'll find many uses for pinned (and unpinned) annotations. Let us know if you find a particularly useful way to use this new capability.

.- Chip

PANIC AND FEAR? NO SIGNS JUST YET

I'm the conservative type. I'm also nervous. I never like to see the market fall precipitously while market participants yawn. In a nutshell, that's what we've been seeing. Yes, the talking heads will say the sky is falling, but unfortunately for bulls, that's not the case amongst those actually trading the market. I've provided in previous articles how the put call ratio correlates to market tops and bottoms. I won't go into the details again. However, everyone needs to understand that market participants are not panicking yet. That is a very big clue to me that we've got more work to the downside before we can declare a bottom. It doesn't mean we can't bounce and I'll provide an argument below that suggests a near-term bounce is imminent. But it will likely be just that - a bounce.

First, let's talk sentiment. Thursday, the put call ratio printed a closing reading of 1.21. Finally! It was the 3rd highest end of day reading since the mid-March lows. That's the good news. The bad news is that one day of negative sentiment doesn't mark a bottom. Below is a favorite chart of mine, measuring the 5 day moving average of the put call ratio against the 60 day moving average. It simply plots the short-term pessimism against the longer-term pessimism, and provides us with a measure of relative pessimism. I like to see the short-term 20%-30% higher to begin to mark bottoms (and 20%-30% lower to mark tops). From Chart 1, you'll see we're simply not there yet so strap on your helmets and buckle your seatbelts.

We could continue lower, the pessimism could build, and a significant bottom could form in the near-term. Given the severely oversold conditions though, I expect to see a bounce first and that will likely return the 5 day put call ratio down closer to the 60 day moving average, possibly even below the 60 day. Furthering my belief of a short-term bounce is the positive divergence that has printed on the 60 minute charts. The major indices have put in new lows the last 3 days, and with each new low has come a higher MACD reading on the 60 minute chart. Take a look at the NASDAQ below in Chart 2.

I'll leave you with one more chart to ponder. Normally when the market sells off, the Dow outperforms the NASDAQ. That makes perfect sense as investors flock to high quality, "safer" investments. From Chart 3 below, you can see that the ratio between the Dow and the NASDAQ moved much higher during the summer of 2006 and again in fall of 2007 into the first quarter of 2008 as the market sold off hard. Any time this ratio moves up, it indicates relative outperformance by the Dow. A declining ratio suggests relative outperformance by the NASDAQ. Here's the interesting part: Since the May 19th top, this ratio has actually declined. We just suffered through the worst June in several decades, yet the money did not gravitate towards the Dow - interesting indeed. Is this a short-term phenomenon that will rectify itself in due time? I say yes. I've highlighted the recent move up in the ratio and believe that the move above the recent high is technically significant.

We'll find out in time. In the meantime....

Happy trading!

BEAR MARKET EXPANDS!

Sector performance in May and June shows the bear extending its grip into other key sectors. The Financials SPDR (XLF) and the Consumer Discretionary SPDR (XLY) woke up the bear with dismal performances in May. The first PerfChart shows sector performance from 1-May until 2-June, which is basically the month of May. XLF and XLY led the way lower in May. Notice that the Industrials SPDR (XLI), Materials SPDR (XLB) and Technology SPDR (XLK) held up relatively well in May. In fact, selling pressure in May was pretty much limited to the financial and consumer discretionary sectors.

The second PerfChart shows sector performance from 3-June to 1-July, which is basically the month of June. There are two items worth noting here. First, the Technology SPDR, Industrials SPDR and Materials SPDR declined rather sharply in June. These three held up in May, but fell apart in June as selling pressure expanded among the sectors. Second, the Utilities SPDR (XLU), Consumer Staples SPDR (XLP) and Healthcare SPDR (XLV) held up the best in June. Well, outside of the Energy SPDR (XLE) that is.

Utilities, healthcare and consumer staples represent the defensive sectors. No matter what happens in the economy, we still need electricity (XLU), toothpaste (XLP) and medicine (XLV). While the S&P 500 moved lower in May and June, XLU edged higher both months and showed relative strength. XLV and XLP are down over the last two months, but less than the S&P 500 and this shows less weakness, which can also be interpreted as relative strength. Fund managers that are required to be fully-invested in stocks are no doubt watching these relative performance numbers and looking for the sectors that are holding up the best.

VERY DANGEROUS MARKET

A bullish take on the stock market would be that (1) market indicators are very oversold, (2) there is a triple bottom setup on the S&P 100 Index, and (3) sentiment polls show a lot of bearishness. I agree that those conditions exist, but we are in a bear market and these conditions can easily see price movement transition into a crash. The reason, as I have said many times before, is that bullish setups don't always work so well in bear markets, and an oversold market can very quickly become significantly more oversold.

Let me be clear, I am not predicting a crash. If the market does crash, I will not claim to have "called" it, because that is not what I am trying to do. I want my readers to be aware of the danger and not try to pick the exact bottom of this decline. That bottom could be very far away.

Our first chart contains three indicators (one each for price, breadth, and volume), and you can see that they are all very oversold. You can also see the triple bottom setup. This oversold condition is repeated on most of our other indicator charts.

The next chart looks more closely at how prices have been behaving in response to short-term oversold conditions. Note how during the recent decline that oversold indicator readings have not resulted in anything but tiny advances that were quickly followed by continued price declines. This is typical bear market behavior, and it implies that medium-term oversold readings may be just as soft.

Our final chart gives us a view of just how much complacency exists, in spite of widely negative sentiment readings. The Volatility Index (VIX) is derived from prices on near-term SPX put and call options. Higher readings reflect a high level of fear among options traders, and lower readings complacency. Note the upside spikes on the VIX at the January and March lows. Now note how the VIX is currently about mid-range, even though prices are making new lows. This shows a surprising lack of fear, considering what prices are doing. (Thanks to Ike Iossif for bringing this to my attention.)

Bottom Line: We are in a bear market, and it is suicide to try to take positions anticipating the next rally merely on the evidence that the market is very oversold. Conditions are such that a sharp decline could materialize at any moment. This is not a prediction -- I don't suggest placing bets on it -- just something that traders should consider. Bear markets are dangerous. Wait for solid evidence that a rally has begun before sticking your neck out.

We rely on the mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have included the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

SITE NEWS: "UNIVERSAL LOGIN" NOW WORKING

"UNIVERSAL LOGIN" NOW WORKING - We've finally, finally, finally fixed something that has been bugging lots of people for a long time. In the past, we had two very different ways to log into our website. People who subscribed to our Extra or Basic charting service logged in using the boxes on our homepage. People who subscribed to John Murphy's Market Message logged in by clicking the "John Murphy" tab and then entering their information in the popup box that appeared. People that subscribed to both services had to enter their information in both places (ugh!). WELL NO LONGER! Now, everyone can use the boxes on our homepage to login regardless of their subscription type and "combo" subscribers can move between the charting sections and the Market Message area without getting harassed a second time. Finally!

SECTOR ROTATION SAYS BEARISH

SECTOR ROTATION MODEL... One of our readers asked where we are in the Sector Rotation Model. That model shows the normal sector rotation that takes place at various stages in the business cycle. The chart shows that basic materials and energy are market leaders at a market peak. As the economy starts to slow, money starts to rotate out of those two inflation-sensitive groups. Basic materials peak first and energy last. This week's downturn in basic material stocks suggests that the topping process is moving even further along. Energy may be the next to roll over. As the economy slows, money flows into consumer staples, healthcare services, and utilities. That's where we appear to be right now. One way we can tell that a bottom is near is when money starts to flow into financial and consumer discretionary stocks. So far, there's no sign of that happening. That leaves us in the midst of a bear market with money flowing toward staples, healthcare, and utilities.

STOCKS LEAD THE ECONOMY... Everytime I show the Sector Rotation Model, I feel the need to point out that the stock market (red line) peaks well before the economy (green line). Although most of us are aware that the stock market is a leading indicator of the economy, that point keeps getting lost on Wall Street and the media. Ever since the market peaked last fall, the media has presented a parade of economists arguing that the economy was still on sound footing. I remember seeing a headline "fear versus fundamentals" back in January (that was repeated again this week on CNBC). The implication being that the market was falling on "fear" instead of "fundamentals". With the stock market having had one of the worst first halfs in decades, we're now starting to get confirmation that the economy is in bad shape. It's a little late for that to do anybody any good. That's why we study the market and pretty much ignore the media, economists, and Wall Street suits.

NOTE: John will be on vacation next week.

UNAVOIDABLE BAD NEWS (AND HOW TO AVOID IT)

Hello Fellow ChartWatchers!

This week's edition of ChartWatchers is full of important information including a lively debate about the health of the market - Tom Bowley is actually optimistic (well... somewhat), Arthur Hill not so much. But first, I have several items that are super important for our members:

BAD NEWS: WE'RE GOING TO RAISE OUR PRICES BY US$5 PER MONTH

Behind the scenes here at StockCharts, the sad fact is that the data vendors have been continually increasing the price they charge for their data. We have been protecting our subscribers from those price increases for as long as we can. In fact, we have NEVER raised prices going all the way back to when we started the website back in 1999. (How many other things do you know of that are the same price as they were back then?) This is a first for us and we are not happy about it.

Starting August 1, 2008, the price of all of our services will go up by US$5 per month. One month of Basic will be US$14.95, one month of Extra will be $24.95, and one month of ExtraRT will be US$34.90. Longer term subscriptions will also be going up at the fixed rate of US$5 per month.

We know that with the price of gas putting the squeeze on everyone these days the timing of this increase couldn't be worse, but we hope that everyone will consider the fact that we've keep prices as low as we could for as long as we could when considering renewing. Oh, and by the way...

GOOD NEWS: YOU CAN AVOID THE PRICE INCREASE BY RENEWING IN JULY!

Notice how I said "Starting August 1, 2008" above? That means that you can avoid (or at least significantly delay) the price increase by adding a long-term renewal to your subscription during the month of July. Even if you renewed recently, you can re-renew and we will simply add more time to your expiration date. By renewing now, YOU can determine when the price increase will actually start to affect you. Oh, and by the way...

GREAT NEWS: THE SUMMER SPECIAL IS NOW ON!!!

Just like in the past, we are running a special during the month of July: If you renew for 6 months, we'll give you 1 month free. If you renew for 12 months, we'll give you 2 months free. This is the best deal on our prices and, with the looming price increase in August, this is the last time you'll have a chance to get this deal ever.

So...

My strong advice to current members is to renew your account today for 12 months. You'll get 2 additional months for free AND you won't have to pay our increased prices until at least November of 2009. Seems like a no-brainer to me.

If you aren't a member but are thinking of joining, now is really the time. If you delay until August, it will cost you - it's just that simple.

To get started, simply click this link and follow the instructions.

Again, we're just as unhappy as everyone else about rising prices and we will continue to do our best to make sure you get the most value for your money here at StockCharts.

 - Chip