Whatever Happens, Let's See a Rally First

 | Aug 04, 2017 | 6:00 AM EDT
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About three weeks ago, I found myself writing on these pages about the "upcoming overbought" reading. It was due to show up around July 14.

You might recall I noted the oscillator you see here daily was overbought based on the breadth of the market. When we've had a long string of positive readings, we consider the market overbought. Conversely, when there is a long string of negative readings in our recent past, we consider the market oversold.

Last month, we had the oscillator overbought and I had done some calculations to show that, using price and a momentum indicator for Nasdaq, we were overbought. At the time, I also noted that this year the overbought readings tended to show up more in terms of the price of the Russell 2000 rather than in the senior averages. Once again, that seems to be the case.

The Russell 2000 is now down 3% since mid-July. I'd call that an overbought pullback.

Now it finds itself sitting at support around 1400, having broken -- rather handily -- the uptrend line and its 50-day moving average. And I suppose a bounce off the 1400 area could supply the chart with the right shoulder of a head-and-shoulders top. It's possible, isn't it?

Take a look at the Overbought/Oversold Oscillator for Nasdaq. It has plunged (see the Russell). It is somewhat oversold, as you can see. I have placed two green arrows on the chart that coordinate with the same arrows on the chart of the Russell above. The arrow in March had a one-day lift and we came back down, rallied again and then plunged one more time.

I have been of the mind that a rally now would lead to another decline starting around mid-August. So perhaps there is some coordination to be seen here. Perhaps the employment number helps lift the market for a minor oversold rally.

After all, the put/call ratio was 101% on Thursday, the first reading over 100% since July 11 (just before we reached that overbought reading!). So there is some concern creeping into the market.

However it plays out (my preference is a rally first), there continues to be quite a bit of weakness underneath. The number of stocks making new lows on the NYSE expanded on Thursday, something we had not seen lately; we had only seen Nasdaq's new lows expanding.

When we see such weakness underneath, it typically needs to swing to the other extreme before there is a decent setup for a rally. That means the VIX should eventually complete the W pattern I have laid out. The put/call ratio should soar well over 100%. The S&P 500 should break a level that concerns folks, instead of flatlining. The Investors Intelligence bulls should come down from the current 60% reading. Maybe we'd even get a day where the TRIN goes over 2.0.

And to answer the question I am sure I will be asked: I have no idea what would bring that on; if I knew, I'm sure it would already be priced into the market.

For more market analysis from Helene Meisler, sign up for Top Stocks, published five times a week.

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