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A TEST OF THE LOW?

The stock market is a master of disguise relative to telegraphing its next move. As my late mentor and friend, Paul Desmond, of Lowry Research Corporation often observed: “The role of the stock market is to deceive most investors most of the time”. The events of this past week is certainly another example of this phenomenon.

On Monday the market opened heavy and immediately began to extend the recent decline, and by the close virtually every stock group had been mauled, and nearly every market metric ended in their severely negative range. These kinds of universally negative days are often followed by 3-5 days of rally after which lacking a 90% upside day, or two consecutive 80% upside days, the decline will likely continue until those upside days eventually appear to signal evidence of resurgent demand, and the likely end of the correction. This sequence has been well documented by Lowry Research over the years.

In the current case, on Tuesday a rally began, which by the end of the week had recovered over 50% of the decline (see second chart above), but less than the 62% level. Often if a recovery rally can exceed the 62% level, then the odds favor the correction being over, and the implication is a new assault on the highs would have favorable odds. I had expected a “test” of Monday’s low to develop after a brief bounce, which still may happen, but I must admit that the almost instantaneous recovery of over 50% of the decline was unexpected relative to my decades of observing these kinds of events. And, such a strong recovery does cast a shadow on the ‘test” of the low notion.

To further muddy the picture, Monday’s decline pushed our TATY indicator intraday into threshold of the caution zone surrounding the 115-125 level. A weekly close in the caution zone would have triggered the first step of a “Big Chill” warning needing only a follow on, but stalling recovery rally into, or near, the red zone to actually trigger the warning. However, by the end of the week TATY was showing some signs of painting out a weekly bottom in the red zone signaling that demand was still in the superior position to supply, the dramatic Monday intraday plunge notwithstanding.

TATY —   A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS

 

TATY is shown above in yellow with the S&P-500 overlaid in red and blue candle format. TATY finished the week in the red zone at the 140 level. Where this indicator finishes over the next several weeks will be critically important in diagnosing, if the stock market is painting out a major top, or on the contrary is just the stock market experiencing a normal breathing in and out type correction to reinvigorate demand. A weekly print in the caution zone surrounding the 115-125 level would be the first step toward the issuance of a “Big Chill” warning, which has preceded every major top, and major rebound counter-trend rally during bear markets since the 1990’s.

In the current case, should TATY continue its recent history of painting out bottoms in the red zone, then the correction has likely ended, which implies more assaults on new all-time highs to come. However, if the stock market has experienced only the first leg down in an ongoing correction, then how TATY responds to the next leg down, or “test” of the Monday spike low, will become of critical importance. For now I will posture accounts for a “test” of Monday’s low, which means there may arise an opportunity to put excess cash to work should a “test” of the low result in a new tactical buy signal being issued by SAMMY.

SAMMY   —   A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS

SAMMY shown above alone, and below with the SPXL 3X leveraged S&P-500 ETF overlaid. The SPXL leveraged ETF is for reference purposes only.

SAMMY has not yet issued any new buy signals, as it remains near the outer edge of its recent downtrend. This tactical indicator is implying that there may be a “test” of Monday’s spike low by the price. If there is going to be a new buy signal issued by SAMMY, then for the time being the indicator’s steep decline implies the buy signal may still be several days in the future. Although the price has rebounded sharply, SAMMY is not likely to be able to turn higher quickly given its incorporation of derivative modules into its supply and demand type formulation.

THE BOTTOM LINE

Given the sharp recovery in the price, and the current readings for the strategic big picture balance of supply and demand, there is some reasonable odds that a quick and nasty correction ended on this past Monday’s spike low. However, relative to my decades of experience, this would seem to be a statistical outlier of an outcome. Consequently, I’m inclined to treat the current situation as a complete leg down in a correction with a recovery rally underway, which will likely yield to at least one more leg down before adding excess cash into the market could be considered as a low risk buying opportunity.

I deal only in objective hard numbers generated by the market itself. However, as an unofficial observation there appeared to be a large institution(s) keeping a steady bid under the futures after Monday’s plunge. In another life, we affectionately referred to this kind of market behavior as “the plunge protection team at work”, an outfit whose existence is denied, but some of us are suspicious exists, to the detriment of short sellers. I watched the S&P-500 futures tick by tick on Thursday, and the bid was so strong and persistent that every attempt to decline was met with buying, and some could make the case that the futures were pulling the cash market higher.

 

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