Short-term Outlook:  Neutral  From Feb 19, 1112 SPX

Equity Indicators - Updates and Extremes

Oversold Breadth Then High Momentum

A few weeks ago, we had a large number of indicator readings suggesting that we were seeing excessive pessimism.

That's usually a good sign, and according to everything we looked at at the time, we were oh-so-close to what should have been a good multi-week buying opportunity.  But the stars just didn't quite line up, as we got an unreliable reversal bar too early (on February 5th) and it simply didn't trigger the bullish precedents we had studied.

Now we've seen a market that continues to recover from any intraday weakness every single day, to the consternation of many (yours truly included).

Let's see if we can find some meaning in this.  Let's look for any periods where the market becomes oversold (defined as an Up Issues Ratio under 40% on a 10-day average), then we see extreme momentum.  "Momentum" can be defined any number of ways, but in this case we'll look at a favorite of short-term traders - the 2-period Relative Strength Index (RSI).  It has been above 90% for the past four days, an unusual accomplishment.

Typically when we see a market that gets very oversold, then enjoys high momentum within a month, it means the correction has ended and the market will continue its upward path.

We don't really see that with this study.  The results going forward were not bearish by any means, but they also weren't meaningfully above random.

Interestingly, the figures were even worse when we were in a bull market at the time (defined simply as an upward-sloping 200-day moving average on the S&P 500).  In those cases, three months later the S&P was up 60% of the time by an average of +1.9%.  If we were in a bear market, though, it was up 73% of the time by an average of +3.5%.

The reason is that during bear markets, this kind of setup most often signaled the end of a much longer-term decline, and consistent buying pressure like we've seen recently tends to continue as traders believe the end of the bear market is in sight.  In bull markets, however, by definition markets have already rallied substantially, and we don't have that same kind of "get me in" mentality - too much buying pressure has already been used up.

For those who are interested, here are the dates and S&P performance going forward: