Executive Summary:
One week ago, investors fretted about keeping up as the stock market winners continued to march higher on a daily basis. But as the saying goes, trees don't grow to the sky, and our Early Warning Board gave us ample time to recognize that the "table had been set" for some counter-trend action.
I wrote last week:
"My guess is that when the bears do finally find a raison d'être (and they will, it's only a matter of time), we should expect the selling to be intense for a few days."
I also opined that since we had a "good overbought" condition going, a catalyst would likely be needed for the bears to get up off the mat. Normally, a headline, a tweet or a shift in policy would be the trigger for the bears to get a selling party started. This time it was strange action in options and volatility that appeared to be the catalyst for the fastest move from an all-time high to "correction territory" on the NASDAQ Composite in history.
After a quick dance to the downside, which took the Nasdaq 100 down 10.9% and the S&P 500 nearly 7% in three days, stocks quickly reached oversold territory. As is usually the case, a bounce then ensued. Which brings us to today and the question of, where do we go from here?
My base case is we are seeing a correction within an ongoing cyclical bull market. We'll be watching the intermediate-term momentum indicators closely in the coming days/weeks as our key "tell" on the subject. In short, if the intermediate-term breadth indicators hold up (so far, so good), we can assume the bulls will regain control at some point soon. But if not, then some additional downside exploration can be expected.
Now let's take a look at our Early Warning Board for clues about the near-term action.
The State Of Early Warning Indicators
The Early Warning Board has clearly shifted this week. And while there is no "table pounding" message at this point in time, the bulls appear to have a slight edge on the board. However, I would expect the bears to put up a fight in the near-term in order to "test" the bulls' resolve going forward. And while the dip buyers could always run the indices right back to the highs, I'd prefer to see some further consolidation to further dampen the speculative froth that had developed. And since this pullback appears to have been driven by technicals, my best guess is the bulls will return to form in the next week or so.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability.
Stochastic Review
Last week, with the market overbought and investors clearly having become complacent, I wrote, "If the market follows the script, we can expect a scary decline in response to whatever fear comes out of the woodwork next. These bouts of selling tend to be short and sharp, and in my experience, represent a good time to put additional funds to work."
Sure enough, the ensuing decline unfolded as expected. The quick trip down pushed the stochastics into oversold territory and yesterday's reversal has triggered a short-term buy signal. The key from here will be whether or not the bears have any staying power and can produce a more prolonged oversold condition – which would be preferred from an intermediate-term perspective.
S&P 500 – Daily
Thought For The Day:
Not getting what you want is sometimes a wonderful stroke of luck.
- Dalai Lama