That Pullback Was a Start

 | May 07, 2014 | 6:35 AM EDT  | Comments
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Stock quotes in this article:

coh

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bac

,

jpm

,

twtr

Note: Helene Meisler will be traveling for the remainder of the week. Her next column will appear Monday, May 12.

I realize you probably don't want to hear this, but declines are good. They are healthy.

Seemingly everyone wants to believe that it's a blessing when a market rallies forever. But it is not -- because such action never offers the market a chance to shake out weak holders or allows it to reset itself. When a market incessantly rises without correction, stocks eventually work their way into weak hands as latecomers arrive. The higher the price you paid for your stock, the lower your ability to hold on.

This is one reason I keep harping on how declines are better than a continued grind upward with negative divergences. When the market slides, we at least get some panic and fear. We can see where the weak holders are, as well, as the strong ones are willing to take a stand. In that respect, while my wish for a Tuesday decline was realized -- and while the charts look awful and the statistics continue to weaken -- at the very least it all puts the market on a better path.

To reiterate, and as essentially everyone knows by now, this year is much changed from 2013. For the last two years -- and maybe more -- any gap down was a considered a reason to buy, regardless of whether that decline came on earnings or just general bad news. As I've said, I believe we've created an entire generation of investors who believe every gap down is a gift. But there was a time that gaps down were just that: gaps down -- and with more downside to come.

This year has produced a big switch in that action. Just look at a stock such as Coach (COH), which gapped down and has continued pulling back. Bank of America (BAC) has done the same, and so has JPMorgan Chase (JPM). I won't even list the momentum stocks that fall into this category, even as many folks are quite focused on Twitter (TWTR) and the blow-ups in "momo" land.

That notwithstanding, please look at the ratio between the KBW Bank Index and the S&P 500. This is a two-year chart and, as you can see, it is now back where it had been one year ago.

This ratio had been in a steady uptrend of higher lows from June 2012 through last summer, but at this point that trend has eroded. In particular, the move down since early April has been nothing short of incredible -- and even more so for the fact that seemingly no one is focused on it.

In addition, the Russell 2000 finally broke below its 200-day moving average Tuesday, putting in its lowest close since Feb. 5. That said, the intraday lows were still higher than the two we've seen since mid-April.

This is the deterioration that we see in the statistics. This is why we care about the number of stocks at new highs. Sure, the S&P may hang tough at the highs, but unless you own that index, these charts are likely more indicative of what your portfolio is doing.

The one piece of short-term good news is that the Nasdaq -- though not the NYSE or the S&P -- now leans toward an oversold condition. Also, the put-call ratio on the CBOE Volatility Index (VIX) slumped to 15%, and we'll typically see a rally after this indicator pushes under 20%. At the same time, the put-call ratio for ETFs read above 200%, another metric revealing signs of some fear.

So a short-term rally is doable. The problem is still the downside: Until we see some positive divergences as stocks go red, the upside will remain limited. As a result, I would expect any rally to fail.


 

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