Buy or sell this resilient stock market?

Mid-week market update: I have been calling for a period of consolidation and pullback and that phase of the market seems to have arrived. As the S&P 500 weakened and the VIX Index spiked above its upper Bollinger Band, indicating a short-term oversold condition, this stock market has been remarkably resilient. The 5-day RSI traced out a positive divergence, and the NYSE net new highs remained positive during this episode.

Does this mean the correction is over?
 

 

One more flush ahead

I would argue that there is at least one more flush ahead for the market. I outlined a number of criteria for a market bottom last weekend (see How to spot the correction bottom). One of them was to see what happened when the S&P 500 Intermediate Breadth Momentum Oscillator (ITBM) flashed a sell signal when its 14-day RSI normalized from an oversold condition against a backdrop of an extreme overbought condition for the stock market, as measured by the percentage of stocks with P&F buy signals turned down from the 80% level. The study published on the weekend considered a five-year period, which yielded a very limited sample. I went back 20 years and the accompanying chart shows the 20-year period of this signal.  Here are my main takeaways:

• These sell signals were extremely powerful tactical sell signals, which are marked by vertical lines. All except one were successful (dotted blue line).
• Market declines stopped when the 14-day RSI of ITBM (top panel) and the NYSE McClellan Oscillator (NYMO, bottom panel) reached oversold levels.

As these conditions haven’t happened yet, market history indicate another downleg to stock prices.
 

Put it another way, here are the four components of my Bottom Spotting Model. Only one component, the VIX Index has flashed a buy signal by spiking above its upper Bollinger Band. Historically, this Bottom Spotting Model has been effective at calling short-term bottoms when two or more components flashed buy signals.
 

 

In the short run, however, this market has been very resilient. When news broke yesterday that Italy imposed a surprise windfall tax on banks, which the government later backtracked on, and Moody’s downgraded a number of U.S. banks, the relative performance of financial stocks held up and remain in relative uptrends.
 

 

I conclude from this market action that the market is correcting, but may be undergoing a reflex rally. We probably haven’t seen the bottom of this corrective phase and the market needs one more flush and panic before it’s all over.