The BKX Is Near A Low

The BKX Bank Index has completed 5 waves down from the May high or nearly so. While the broader indexes may need 1 to 2 more weeks before a substantial rally, the financials may begin to rally now. This should not be interpreted as strength, although it may fool a lot of people, but rather this is due to the fact that the financials have led the way down and have become oversold sooner than the rest of the market. While it is possible that the financials have further to go on this downleg, the risk is now for a sharp bounce. I will be exiting the SKF on Monday and look to re-enter on a pullback.

In my last post I said that stocks are not oversold. To clarify, the indexes are a bit oversold and due for a bounce, which fits with this holiday week, but the stocks making up the indexes have significant room to the downside, so expect a resumption of the downtrend after a brief bounce possibly lasting until July 7 or 8.

Stocks Are Not Oversold!!!

It sounds amazing after a day like today, doesn't it, but a sort I run every night on the major index components is saying just that.

Every night after the close I sort the Russell 3000, S&P 500, Nasdaq 100 and the Dow 30 by the 5 period RSI and I track the number of stocks in each index at or above RSI5 = 95 and at or below RSI5 = 5. This has proven to be a very good indication of how oversold or overbought the market is. After the huge decline today there are fewer stocks oversold than on Monday 6/23/08. I do not interpret this as a positive divergence since there was no swing low intervening these days.

There are many other indicators saying the same thing. For example, volatility is still quite low given the extent of the decline since early June, and the TRIN closed at a modest 2.02 today.

This market may be in the third wave of the decline from the May/June highs, but I expect at least a short term bottom by July 9th. The time window for the 20 week cycle low extends from June 23 to July 7 plus a 2 day allowance. Normally, this would be followed by a 4 to 8 week rally, but don't count on much this time around. The larger cycles, the 4 year and 4o week, seem to be dominating right now, which may not allow for much upside. This is the time to stay in cash or stay short until the 40 week cycle low around November 23. Experienced traders can add to short positions on rallies as long as the May/June highs are not exceeded and proper position sizing and money management is used.

GE Breakdown

GE has long been considered a bellwether for the economy. Let's take a look at a monthly chart of GE. The lower trendline of the rising channel from the 02 low has been broken decisively, and the 06 low has been taken out. The probability is very high that the 02 low will be tested by the end of the year, which does not bode well for the economy or the stock market.

On the other hand, the Qs are holding up fairly well while the Dow and the S&P500 are heading for their March lows. Three of our systems are still long or neutral at the moment. I suspect that the Qs will make an attempt at a new rally high in July while the broader markets make lower highs.

Currently, we are headed into the 20 week cycle low due June 23rd, but the low will probably extend into early July. Typically a 4 to 8 week rally would be expected to follow, which may be a good long opportunity for the Qs unless they break down dramatically in the next two weeks.

But be patient, the low is not in yet.

Rally Fails

IBD has called the rally from 5/23/08 a failure in its current outlook. Following IBD, we will go short the Qs on the open today. The VLE system is just shy of a short signal. Cabot's Tides and the Monthly Weekly price trend systems are also close to sell (neutral) signals.

QQQQ Double Top

(Click To Enlarge)

The Qs are setting up almost identically to the 10/31/07 top with a negative divergence. The current top is also a double top. From the 8/16/07 low to the 10/31/07 high was 53 trading days. From the 3/17/08 low to the 6/5/08 high is 56 trading days. Of course, such comparisons rarely play out in the exact same manner, but if it were to do so, we can expect a decline to 44.71 in 8 to 17 trading days depending on where you count the low last November. There is support at the downsloping trendline which may hold it above that level.

After the June low, we might expect a similar 4 week+- rally followed by another severe decline into the 9 month cycle low in November. The last 9 month cycle low was January 24, 2008. (As a side note, the 9 month cycle is really 10 months on average. This fact allowed me to predict the last 9 month cycle low to be January 16, 2008 just 6 trading days ahead of the actual low.) Currently, we are on the downside of the 20 week cycle which is the 9 month half-cycle due to bottom around June 24. The strength of the next rally will indicate whether the fall decline will be mild or severe.

Followup On Investor's Business Daily

Not surprisingly, IBD changed its Current Outloook to "9th day of attempted rally for Nasdaq". However, I wouldn't be surprised to see it changed to "Market in correction" by the end of next week. This kind of action is what leads many traders to get confused or jump ship. IBD hasn't done anything wrong here. In general, its commentary can be trusted, but experienced traders should be able to form their own opinions and act accordingly.

With the Dow heading lower, it may be only a matter of time before the Nasdaq turns tail and catches up to the downtrend.

Market Resumes Uptrend?

IBD has called for a resumption of the uptrend based on the action of leading stocks yesterday. However, by definition a follow-through occurs when one or more of the major indexes advance 1.7% (this has changed over the years) on increasing and above-average volume, which did not occur yesterday.

I think IBD is premature in calling for a resumption of the uptrend, particularly given the comments surrounding the last market call. ( See the previous post ) The Dow Industrials and S&P 500 remain in downtrends and Oil appears to be heading higher again. While many leading stocks did fare well yesterday, the rally was very narrow.

Look back to early 2006 and 2007 and you will see other instances when the market behaved this way, only to be followed by a selloff. My best estimate is that the markets will top out today or Monday with a low in late June followed by a last speculative surge before beginning a greater selloff. Nevertheless, we will follow the signals and not opinions.

Following Investor's Business Daily

I want to share some thoughts and observations about William O'Neill's market strategy and Investor's Business Daily.

Back in 2000 and 2001 I tried to follow O'Neill's methods with very negative results. However, I am clear that I wasn't really following his methods. I only thought I was, primarily, because I was too agressive at each announced follow-through day instead of easing in to test the waters. However, in my defense, the Big Picture during the third week of May this year created a sense of deja vu, so I would like to share it with you.

From IBD's "The Big Picture" 5/21/08 - Market In Confirmed Rally:

"Still, other factors point to the market's uptrend remaining well intact. For one thing, the NYSE indexes have become the laggards during this rally.
The Nasdaq has emerged as the market's leading index. Meanwhile, leading stocks have continued to ramp up, breaking out of well-formed bases and banking new highs. In fact, one market sector in particular has been red-hot.
That's the energy sector. Surging oil prices have fueled knockout gains for many oil and gas stocks, be they drillers, exploration and production firms, services providers or other related companies."

From IBD's "The Big Picture" 5/22/08 - Market In Correction (One Day Later):

"The body of evidence now points to a market undergoing a correction. Even before the distribution days started piling up, the major NYSE indexes were hitting new highs on weak volume.
In fact, it has been more than two months since the NYSE gauges have registered any kind of up-day in above-average trade.
The market showed its lack of staying power in its inability to clear key levels of resistance. The main indexes all ran up against their 200-day moving averages recently, only to run out of gas and turn lower.
A lack of breadth among leading stocks also has been a problem. On any given day lately, you may have seen roughly three-quarters of the market's top performers hailing from the energy sector. A strong market rally usually wields broader leadership."

I am not trying to be critical of IBD per se, but I wanted to point out the pitfalls for the inexperienced trader. Given the article on 5/21/08, the novice might have been content to ignore the change in market stance on the next day. However, experienced traders would have already been trimming positions as the "distribution days started piling up".

It was all the more confusing that the arguments used to justify maintaining the "Market In Confirmed Rally" stance on 5/21/08 were the same arguments used to support the "Market in Correction" stance on 5/22/08.

Even so, Investor's Business Daily has a great track record, so let's see how well we can do this year by trading the Qs off of IBD's Market Outlook. In the System Tracker, I have added the IBD market calls this year. So far, it is up over 16%.

Following IBD may prove to be the easiest way to make money in the market.