Let's Pull the SOX Up to Explain the Rally

 | Aug 23, 2017 | 6:00 AM EDT
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Everyone was searching desperately for reasons why the market rallied on Tuesday. I can give you one: It was oversold. Oh sure, some will say it was the prospect of tax cuts or President Trump's speech on Monday evening. I will say a market as grossly oversold as this one will find a reason, any reason, to rally.

The curious thing is that so few were skeptical of the rally once it began. My inbox was filled with folks telling me the correction is clearly over and it's time to get on with the upside and new highs. That might be the case, but I have a chart I want to share with you that might have a different view.

For this chart, I take the spread between the 50- and 200-day moving average lines of the Semiconductor Index (SOX) and then plot the daily change in the spread. The thinking is that it typically moves in penny increments (gradually), but when it starts moving in big chunks we are either oversold or overbought. Under the green line and we're oversold.

With only one exception (July 2006) was the push under the green line (oversold) "the" low for the SOX. On the far left of the chart is the decline into the summer of 2002. Market folks who have been around a long time will recall we made a low in late July that year. The SOX rallied about 10% in a few days, fell to a lower low and then rallied again. And then it started a long descent into the October low. Go back to the chart above and notice the October low is a higher low on the indicator.

Now let's look at 2004. The red arrow equates to the spring low in the SOX. There was a 10% rally. We came down again, rallied and then went into a long slide down until September (blue arrow). Once again, there was a higher low in the indicator and a lower low in the index.

I have already noted in 2006 there was no retest. Now let's look at 2008-09. That's boxed in blue on the chart above. The SOX, along with everything else, made a low in late October, enjoyed a rally into Election Day and then came down again.

Notice the rally off that giant oversold reading was short-lived, then we came down again. November was actually the final low for the SOX in that cycle, but we did see a push down again in late February/early March.

In August 2015, we see the massive rally off the oversold condition and the retest in September, but the real retest was months later in February.

So sure, it's possible that this is July 2006, but as you can see that is the outlier, not the norm. Also notice that we need not come down days later. Often it was months later. But that's the pattern. It's that W I harp about so often.

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