Be Alert to the Warning Signs

 | Jan 06, 2012 | 6:32 AM EST
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I promise not to harp on the fact that the number of stocks making new highs was less than half of what it was Wednesday, two days ago -- when the number was lower than the week before. I also promise not to harp on the market being overbought, nor that the 10-day moving average of the equity put-call ratio has hooked upward.

Overbought/Oversold Oscillator -- NYSE

I was asked when the market might be intermediate-term overbought, so let's take a closer look at that today.  As longtime readers will know, I base this on the 30-day moving average of the advance-decline line. Keep in mind that the market only got oversold around Christmas, so it will take a while for it to reach a maximum-overbought condition. Generally speaking, it takes between three and six weeks after this for an overbought condition of any consequence to materialize.

When I look at the numbers the indicator is dropping, going forward, I see a moderate overbought reading next week. At this point I see the maximum-overbought reading arriving toward the end of the month. Generally speaking, this would mean a backing-off mid-month, and then another rally into the end of the month.

30-Day Moving Average of the Advance-Decline Line

The concern with this indicator would come if and when the S&P 500 sees a lower high, accompanied by a higher high or equal high. Notice the lower high (noted with a red line) I have drawn in, which represented the May and July highs in the market. That lower high in the 30-day moving average represented a loss of upside momentum. Not all lower highs give way to the kind of drop we saw in August! More often it's a much milder correction.

For now, we don't know if we'll see a lower high. As such, I'll simply note this: The short-term concerns I have listed in the first paragraph, while quite real, should only lead to short-term pullbacks -- because, as long as the 30-day moving average is not overbought, pullbacks tend to find support. In other words, as I've often said lately, stocks are apt to continue chopping around.

I did note the American Association of Individual Investors' weekly poll Thursday, which chimed in at 17% bears. I have not found a period of time when such a low reading coordinated with an exact market high. More often than not, it takes several weeks to get to a high.

In the past six years, we've seen only two other such low bearish readings. In 2010 one came in late December, after which we didn't see a 3%-to-5% correction until mid-January. A market high didn't come until mid February. In 2005 the reading came in late November. The S&P was near 1270 at the time, and then for the next five to six weeks it traded between 1270 and 1250 -- so, back then, the reading kept a lid on the market.

With the Labor Department's employment number due out first thing in the morning, the one statistic to which I would pay close attention for a short-term market move would be the number of stocks at new highs. If we see a friendly employment number and the market gaps upward, pay attention to any reading that's fewer than 213 new highs on the NYSE. That, coupled with the short-term overbought reading and the 10-day moving average of the equity put-call ratio, would have me looking for some short-term downside.


Overbought/Oversold Oscillator -- Nasdaq

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