It shouldn’t be any surprise to traders that the market has run into a rough patch here. The S&P 500 equal weighted index rallied into overhead resistance in the weekly chart and stalled, which makes sense. This resistance line is the key inflection point for the broader market. If the index can find a bullish catalyst and push through this line to the upside, than the cyclical bull market will like continue and extend. A failure on the other hand makes this rally look like a simple counter-trend rally and puts the indexes back on the defensive.

This is from our daily institutional report:

Watch for Another Bounce

The probabilities favor another short-term bounce to the upside.

Scott Maragioglio  smaragio@epiphanyresearch.com

The market has the set-up in place for a short-term bounce to the upside or a possible reversal to the current corrective action. We believe the market has a more formidable technical headwind than we have seen in previous pullbacks and we are a bit more cautious about jumping in on the long side of the market. With that said, the short-term technical action appears promising for an oversold bounce and a couple of days of upside action, but we’re not going to forecast much beyond that.

The major indexes reversed in late trading on Friday. Prior to the late-day strength the indexes had pushed to extreme oversold readings in several of our indicators. The reversal in the price action eased these indicator readings and left most of our signals unchanged, but the short-term spike in fear was present. The major indexes formed reversal bars at the lower end of the 21-day Bollinger bands. Seeing the reversal bars at the test of the 2 standard deviation bands is encouraging for a potential reversal. We are also looking at the short-term bullish divergences in the stochastic and McClellan oscillators. Bullish divergences like this are supportive of a minor bounce in prices. The VIX also shot out over the upper end of the 2 standard deviation band, which shows a spike in bearish sentiment and fear. We still don’t like the look of the VIX and we feel that the push higher in this indicator looks “incomplete”. In the short-term we would have to view the spike in the VIX on Friday as mildly bullish.

The set-up is in place for a bounce in the indexes. If we see a move higher it would be expected here and we would have to judge the developing strength to determine if it was anything more than a simple relief rally. If the market fails to rally it would be a clear signal to the bulls that the bears are not relenting and the bearish pressure is greater than the bulls expected.

The McClellan oscillator generated a short-term bullish signal on January 19th, which failed. Now the indicator has move into a longer-term oversold position. The market is still under steady bearish pressure, but we’ll see if the market can gain some traction off of the oversold indicator readings. These signals are only good for a short-term bounce. If the market really wants to move lower we should see a fairly quick failure and new lows, which would be a good sign that the bears now have the upper hand.

From last nights institutional report.

Make or Break

The equal weighted indexes are sitting on key support

Scott Maragioglio (813)-748-7570 smaragio@epiphanyresearch.com

The equal weighted market indexes can give us a better look at the price action many times since the indexes lack the “distortion” of the largest-cap names. These indexes can give us a more realistic look at the underlying price action in the market. The S&P 500 and NASDAQ 100 equal weighted indexes are both sitting on key lateral support after minor violations of the long-term uptrend channel. These levels are “make or break” for the market. Any meaningful move lower from these levels will signal a bearish change in the nature of the indexes.

The cap-weighted indexes are showing major trend channel breaks, but we can see that the equal weighted indexes have only minor violations. We give a bit more credence to the latter since it is a more “democratic” measurement of the price action. Our short-term internal indicators have reached oversold levels, which typically suggest a bounce of some measure is likely. The combination of a minor trend violation, lateral support line and short-term internal oversold reading makes this price level important for the indexes. A strong bounce here would put the rally back on track, but a decisive failure at these levels would change the “nature” of the market and could give the bears the upper hand for the first time since March of last year. The 5% decline we have seen so far has driven a surge in bearish sentiment (as measured by the VIX) and corrected the complacency created by the low volatility rise. Our sentiment indicators have flashed short-term bullish signals.

We should get a lot of answers by the end of the week. The strength of any bounce which does develop should tell us what we need to know about this rally. A decisive breakdown below the lateral support lines in the equal weighted indexes will let us know that the bears have taken control.

Our internal indicators are sending us a mixed signal on the S&P 500. The 10-day SARSI indicator has moved to oversold levels. This is a short-term signal and suggests that the market should bounce. The problem is that the 40-day SARSI indicator has penetrated our “40% acceleration line”. A breach of the 40% level in the intermediate-term indicator is typically the “ouch point” for many bullish traders as they realize they are losing ground on over 60% of there holdings. We typically see downside acceleration in prices at this level. We’ll have to give the market a day or two to figure out which time frame is dominant.

The McClellan oscillator – Bollinger band indicator combination has been working very well over the course of this rally. The market rallied today off of a bullish indicator signal, despite the fact that the VIX was very close to a bearish extreme (too much bullish sentiment). We overlay a 21-day 2 standard deviation Bollinger band over the McClellan oscillator to generate bullish-bearish signals.