Setting Up Sheep for Shearing ~ The Risk Averse Alert

Wednesday, April 22, 2009

Setting Up Sheep for Shearing

Here's a technical read confirming my near-term market outlook. It is seen through the cumulative advance-decline line of all issues traded on both the NYSE and NASDAQ.

$NYAD cumulative

Two things are revealed:
  1. Why the market's counter-trend rally off March '09 bottom probably is nearing its end, and
  2. Why any subsequent decline likely will result in only a retest of March '09 bottom, rather than a market collapse.
Per the first point, consider the NYSE cumulative advance-decline line divergence relative to the NYSE Composite, now versus the start of the year. What we see here reveals NYSE-traded issues are not being bid higher at the same velocity they were being sold lower from early-January through early-March '09.

How do we know NYSE-traded stocks are not being bid higher at the same velocity? Simple. The NYSE Composite is lagging its cumulative advance-decline line.

This dovetails perfectly with the second point. When the market was selling off at the start of the year NYSE-traded issues were not being bid lower at the same velocity as occurred during the September - October '08 period. Whereas the NYSE Composite decidedly registered new bear market lows going into March '09 bottom, the cumulative advance-decline line barely confirmed the move.

But confirm it did. And this is a warning, because at true bottom the cumulative advance-decline line can be expected to diverge from the NYSE Composite ... much as it did at the top in October '07.

Still, the cumulative advance-decline line at March '09 bottom does present something of a first-sign that, a supportive bid is entering the market and taking advantage of a growing number of perceived bargains. Thus, we have evidence any decline following the current counter-trend rally likely will result in a retest of March '09 bottom, rather than an accelerated collapse.

Need more evidence the market is nearing the end of its current counter-trend rally?

Consider how the cumulative advance-decline line at the start of the year was higher than where it stood on Election Day '08 (early November). Once again, though, the NYSE Composite had not been bid up (post-11.21.08 bottom) at the same velocity it was throttled after our taller, tanner Herbert Hoover was swept into office. Once again, too, the NYSE Composite at the start of the year was lower than where it stood on election day. As a result of this divergence the market came undone.

And why do we expect the same outcome this time around?

(Three guesses, and the first two don't count.)

That's right, because the trend is your friend.

$NAAD cumulative

Rather than identify the above chart as the cumulative advance-decline line on the NASDAQ Composite, I am tempted to call this the picture of death warmed over. There's absolutely nothing suggesting selling pressure dominating NASDAQ-traded issues is abating. Thus, intermediate-term, expect the path of least resistance to lead the NASDAQ Composite lower.

Duly note, too, NASDAQ's cumulative advance-decline line presently is diverging from COMP (which, right now, trades higher than where it stood at the start of the year). This likewise suggests the end of the market's current counter-trend rally is near.

Per the cumulative advance-decline line's relatively stronger acceleration higher off March '09 bottom ... this, too, suggests COMP likely will but retest its bear market low, rather than collapse. There apparently is an interested bid under NASDAQ. However, not so much to claim a "new bull market." How do we know this? Simply by the lack of any divergence suggesting the bid could be serious.

Yet here again ... with the relatively strong recovery of NASDAQ's cumulative advance-decline line ... we see evidence that, following a retest of March '09 bottom, the market could move right back up and more or less trade within a sideways range for several months thereafter. During this time expect El Swindle Grande to be working overtime sharpening its shears for a trimming of a herd of sucker sheep who forget that, even in the dead of winter a thaw can appear.

Fast Money
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