Give it a Chance to Stretch Out

 | Oct 05, 2011 | 7:01 AM EDT  | Comments
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Note: Helene Meisler will be off Thursday. Her column will return on Friday, Oct. 7.

That was some oversold rally, eh? Of course, it all happened in about 30 minutes, but it does go to show what can happen when those with short positions are forced to run for cover. I did notice that the calls for 1040 on the S&P 500 quieted down today. We'll have to watch that sentiment.

The good news is that the market is still moderately oversold. Keep in mind, though, that it will be back to overbought at the end of the week, just in time for the Labor Department's employment data.

As far as Tuesday's rally, it won't surprise you to discover that breadth wasn't so hot. For all the hoopla on upside volume, neither the NYSE nor the Nasdaq managed to get advancing issues above 90% of the total volume. It will likely also disappoint you that, while there are still fewer stocks at new lows on the NYSE, the Nasdaq managed to exceed its August peak reading.

But today I want to look at the long-term uptrend line on the Russell 2000. On the chart below you can see that, for now, it has held above that line. You can also see how flat it is. Flat lines are, in my view, more important than steep lines. It is easy to break a steep line, but that is not the case for a flatter line -- so if a flatter line breaks and can't be recaptured, that tends to be a more negative sign.

Russell 2000

Now let's take a look at the S&P relative to the Russell. It might be difficult to see, but the outperformance of the Russell during Tuesday's trading took this ratio down quite a bit -- from 1.8 to 1.76. We have this ratio attempt to decline before, and to no avail, but this still bears watching closely.  If the ratio can move lower (which would means the Russell would have to stay above that long-term trendline in the chart above), then we'd be able to discuss a bottoming process.

S&P 500 to Russell 2000

 If this ratio does an about-face and heads right back up, then we would expect that it won't be long before the Russell breaks that long-term trendline. There is a seasonal effect often entailing the small-caps bottoming in the fourth quarter, so the relationship between these two indices is something else that needs to be watched closely.

As for the S&P, which broke the rectangle Monday, the lower line has not yet been recaptured. Since it was slightly uptrending, the resistance comes in around 1135. The inability to recapture that level on the S&P while stocks are still oversold will likely embolden the bears.

S&P 500

In the meantime, we'll give the market a chance to enjoy a bit more of the oversold rally.


Overbought/Oversold Oscillator -- NYSE

Overbought/Oversold Oscillator -- Nasdaq

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