Root for a Lower Low

 | Jun 01, 2012 | 6:23 AM EDT
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I was asked what might lead the market out of the abyss, if and when we ever get that low for which I keep aiming in the second week of June. If a low comes from capitulation -- which is still not evident in the charts -- then typically the stocks getting "smooshed" at the end will be those that rebound the most. Yes, "smooshed" is a technical term!

As for Thursday's trading, I must note that, as soon as we saw a whoosh down that rebounded, my inbox became filled with folks asking if there were positive divergences. Let me explain what a positive divergence is. The first thing that's required is a lower low in a major index. Without a lower low, there is no such thing as a positive divergence. There is nothing to compare -- period.

With a lower low we can see if there are fewer stocks at new lows. With a lower low we can see if there are indicators (I have the Oscillator in mind) that have made higher lows. With a lower low we can see positive divergences. Without one, we can see a bounce from support, but that's all.

So you should actually be cheering for a lower low that has positive divergences, not rooting for a higher low. You should also be cheering for a higher reading in the Investors Intelligence bearish statistic, as that would set up sentiment to where it should be if the market is to get this decent oversold condition in mid-June.

I do realize I have harped about this Investors Intelligence reading to the point at which you are probably tired of hearing about it. But I do believe, as ancient as this indicator is, it has essentially been pretty reliable over the years. It has been around since the 1960s, which I believe would make it the longest-used sentiment indicator, and surely one with the most history.

I realize there's a desire to fuss over the similar readings put out by the American Association of Individual Investors each week, since these folks tend to flip around like a bunch of day traders. But let me remind you that the AAII bearish reading was at 17% in mid-January, nearly three weeks before the Russell 2000 made its high in early February and well before the S&P 500 reached its own high.

American Association of Individual Investors -- Bears

In my experience, the AAII readings are best used when there is confirmation from another sentiment indicator, hence my inclination to wait for the Investors Intelligence readings to get in gear. OK, I'll make one exception: If my mother calls asking if she should sell, then I won't wait for the AAII readings to get in gear!

In the meantime, the chart you should be paying close attention to is iShares iBoxx $ High Yield Corporate Bond (HYG). That high volume on Thursday may have been end-of-the-month positioning, but if the lows from two weeks ago break, then the measured target will be near $84.

HYG -- Daily


Overbought/Oversold Oscillator -- NYSE

Overbought/Oversold Oscillator -- Nasdaq

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