Technical Indications Of A Short Term Bottom

Once again, a little known technical indicator is signalling the arrival of a short term bottom for equities. This is a new twist on an indicator that measures the percentage of component stocks closing above a certain moving average each day. As far as I know, I was the first to suggest the use of a ratio to compare two different moving averages – one short term and the other long term. In fact, this was one of the very first things I wrote about way back in 2006: Timing the Market with Above Moving Average Ratios.

It may be somewhat inelegant label (and quite a mouthful!) but it has been a very good compass for the equity markets. And that’s the reason why I keep referring to it as one of the most useful technical gauges. Most recently it provided a great signal at the spring correction. Once more, the ratio has fallen to almost the same depths:

The chart above compares the percentage of S&P 500 index individual components which closed above their 50 day moving average divided by the same which closed above their 200 day moving average. As you can see, when the ratio spikes below 0.5 things are generally oversold and ready for a bounce back. The chart includes data as of Monday’s close and today’s action has moved it upwards, but only slightly.

At times this indicator can be completely wrong of course. This happens when the denominator and numerator get pushed out of their normal ranges. A perfect example was the depths of the bear market in 2008. During those periods, I prefer to rely on the Coppock Curve to provide a buy signal. But it is important to distinguish between this indicator – which is a short term one – and the Coppock Curve or Coppock Indicator – which is a long term one.

Because of the negative seasonality and end of Fed purchases (also known as Permanent Open Market Operations) it is important to not confuse this technical signal as anything but short term in nature. After five down weeks, there are some whispers of a crash and we’ve already seen one major measure of retail US investor sentiment fall to levels it had not seen since August. And then there is the generally supportive option market activity.

The RSI is another technical indicator that is also suggesting that we should expect an oversold rally. It closed recently just a tad above 30 – a level where the equity market has found support so many times during this cyclical bull market.

But other technical indicators are suggesting that we’re seeing a massive loss of momentum. The Bullish Percent index which measures the percentage of S&P 500 index component stocks at a point and figure buy signal have fallen to fresh lows for the year and the lowest since October 2010. The percentage of S&P 500 index stocks above their 200 day moving average, itself an important indicator of momentum, is also waning.

After remaining within a very narrow band throughout most of the cyclical bull market (between 95%-85%) it has now fallen to 72%, the lowest since November 2010. Finally, the cumulative advance decline lines are looking tired. All this suggests that while the market is short term oversold, we’re seeing a more intermediate shift occur as well. Rather than being all encompassing, it looks like the bull market is leaning into its last chapters, characterized by a much more selective market of stocks rather than a stock market.

I think this aging bull market still has some life left in it and I expect at least a short term bounce. As for whether we’ll see a repeat of last’s year’s summer action, it is too early to tell.