What Nasdaq Momentum Has Led To Before

Posted At 9:15 AM EST

Good morning...We begin the day with a flat indication in the pre-market futures.  Traders have a multitude of earnings releases to wade through, which continues through the evening as the market swallows the bulk of S&P 500 component announcements.

One of the big "look at that!" stats bouncing around is the streak of consecutive up days in the Nasdaq indexes.  For the Nasdaq Composite, we've seen 11 higher closes in a row, the first time that's occurred since 1996.

While it's an easy out to say that the index is "obviously" stretched too far and bound to pull back, historically that would actually be a rarity.  When the streak has gone on this long, it went to at least 12 straight up days 10 of the 19 times, and ultimately up to 19 days at its longest.

That's mildly interesting, but little more than descriptive statistics.  We're more interested in what happened going forward, to see if there was anything consistent about the market's structure that we can apply today.

So let's check each of those instances, and see how long it took before the Composite formed at least a one-month peak, how much of a rally it enjoyed to get to that peak, and the depth of the subsequent decline during the month following those peaks.

On average, it took the index 49 days before it formed a peak, which is fairly astounding.  There is little doubt that the index was at least short-term overbought by the time it hit 11 straight up days, but it took more than two months before topping out to any meaningful degree.  It doesn't mean that the Composite didn't drop at all, it just means that before forming at least a one-month peak, it tended to continue generally higher.

It took at least 4 days before peaking, with none of the instances peaking immediately after hitting 11 straight up days.  Except for two occurrences, the Nasdaq went at least a couple of weeks before topping out.

The average rally before a peak was a healthy +10.2%, with 13 out of 19 rallying more than +5%.  The subsequent declines were sometimes pretty substantial, however, nearly (or completely) erasing the pre-peak rally almost half the time.

This is what we often see with momentum like this - the trend continues in the direction of the momentum, sometimes for an extended period, but it tends to be a "creeper" type of trend that shows consistent gains which are often given back in very sharp, quick reversals as everyone tries to save their gains at the same time.

As for whether we're "overbought" or not, it depends on what we look at and on what time frame.  We discussed many such indications of that last week, and the market rolled right over them - a bullish signal in itself.

Another unusual development is that currently about 90% of all S&P 500 components are trading above their 10-day moving averages, while at least 75% are trading above both their 50-day average and 200-day average.

This is a rare occurrence, with only five precedents since 1998.

Those five other occurrences were 05/30/03, 10/07/03, 12/01/03, 12/29/03 and 11/12/04.  It's probably no coincidence that this cluster occurred as the market was emerging from its last bear market.

The week following those occurrences was mixed, with moderate gains a couple of times and moderate losses a couple of times.  But by one and three months later, all of them showed positive returns in the S&P 500, averaging +2.0% and +4.7%, respectively.

This type of momentum is rare, and has historically resulted in even more gains going forward, especially in the intermediate-term time frame of one to three months.

Bottom line - Intermediate-term Outlook: Neutral (since April 9, SPX 843)

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.

During mid-April, the market held up extremely well in spite of some overbought types of indications.  This is very rare during an ongoing bear market, and is important to keep in mind especially given many of the "this time is different" kinds of studies we reiterated in early May.

While there were - and continue to be - many reasons to consider this rally something different than we'd seen previously in the bear market, I was looking for the S&P to run into trouble if it traded into 940-950, which happened early in June.  I wasn't expecting any kind of waterfall decline to new lows, just more of a pullback than we'd seen.

With the most recent surge in the spread between the Dumb Money and Smart Money Confidence, and the tendency for initial breakouts from volatility coils to be "false", I was looking for the first breakout above 950 to be beaten back.  Now that that's happened and we're nearing the opposite end of the May - June range, we need to see how the market responds to short-term oversold conditions, especially now that we've seen a "failed" rally above the 200-day average.

So far the market continues to do that well, bouncing at least moderately off short-term oversold conditions and technical support.  The rally the past week has put an exclamation point on that, so it continues to be too early to put a fork in the rally.  Given how well the market has responded to overbought conditions, it does bode well for the coming weeks.  That is in contrast to some of the other studies we've looked at (like the Fed study from Wednesday), so obviously that makes things tricky here - at least it suggests that being short in face of rising prices and continued momentum probably isn't a great idea, unless indexes like the S&P can't hold above recent highs (around 950ish).

Bottom line - Short-term Outlook:  Neutral (since July 23, SPX 955)

No change in the basic concept here - the market has completely rolled over a multitude of overbought indicators and studies since last week, powering higher through gaps and intraday dips.  As we've discussed many times, that kind of non-response to overbought conditions usually means even more gains.

Yesterday I mentioned that if the market can make yet another new high with Apple earnings out of the way, banks struggling, the Fed testimony and even the solar eclipse, then there seems little that can stand in the way.  The last time we had a plethora of sell signals and a strong market, the very day that all of the bearish edges expired is the day that the market decided to stage a big decline.  Maybe we'll get that now, maybe not, but the case for continued betting against the rally has become just as stretched as the market itself.

There are some signs of waning momentum and exhaustion based on other technical work (such as DeMark signals), and that's an additional layer of short-term warning here, but as far as the type of work that we concentrate on here, the best bets for looking for a pullback have failed (which is perhaps a sentiment signal in itself) and we're just going to have to sit back and wait for the next setup.

All the best,