Oversold Conditions and Bearish Sentiment Trigger Bounce, Breadth Issues Remain, Tech and REITs Leading (Premium)

The market went through the wringer the last two weeks and the bulls appear to have survived. Today’s analysis looks at the oversold setup and the strength behind the recent bounce. Even though the Composite Breadth Model flipped back to bullish, there are still reasons for concern and we will cover these.

There is a video at the end of this commentary.

Oversold Setup and Bounce for SPY

SPY became oversold on November 30th with four of the five overbought/oversold indicators showing oversold. All five were oversold on December 1st and SPY closed below its 50-day SMA, which is also an oversold condition of sorts. These oversold conditions paved the way for a bounce that started last week and gathered some serious steam this week.

The overbought/oversold indicators are as follows. Momentum Composite is oversold when at -3 or lower. SPX %Above 20-day SMA is oversold when below 20%. SPX 4-wk High-Low Percent is oversold when below -40%. SPX %Above 50-day SMA is oversold when below 30%. 13-wk High-Low Percent is oversold when below -20%.

The Momentum Composite aggregates signals in five momentum indicators. RSI(10) is oversold below 30 and overbought above 70. 20-day StochClose is oversold below 5 and overbought above 95. CCI Close (20) is oversold below -200 and overbought above +200. %B (20,2) is oversold below 0 and overbought above 1. Normalized ROC (10) is oversold below -3 and overbought above +3. Normalized ROC is the 10-day absolute price change divided by ATR(10). -3 means three of the five indicators are oversold and +3 means three of the five are overbought.

The Momentum Composite and StochClose are part of the TIP Indicator Edge Plugin for StockCharts ACP. Click here for more details.

The next chart shows SPY bouncing off the green zone, which is marked by the rising 50-day SMA and broken resistance turned support. This pullback to the 450-455 area also retraced around half of the prior (10%) surge. SPY found support right where it should have found. The battle for support was quite chaotic, but SPY ultimately held with a surge the last two days.

The first indicator window in the chart above shows Advance-Decline Percent surging above +80% on December 1st, which is a one-day breadth thrust (green bar). Advance-Decline Percent was also above +70% the last two days, which is pretty strong. The Zweig Breadth indicator moved below .40 on November 30th and December 1st. This is also an oversold condition and sets up the possibility of a Zweig Breadth Thrust, which would trigger with a subsequent move above .615

Breadth Deterioration                                                                               

The decline from November 26th to December 1st pushed the 10-day EMA of Advance-Decline Percent below -30% for the S&P 500, S&P MidCap 400 and S&P SmallCap 600 (red arrows). This is a bearish breadth thrust and the first time all three have been below -30% since March 2020. Such breadth thrusts are the early warning indicators, but are also the most prone to whipsaw. These signals have yet to be reversed and more strength is needed to push them back above +30% (bullish signal).

The 10-day EMA of S&P 500 AD% moved below -30% for a bearish breadth thrust and S&P 1500 High-Low Percent moved below -10% (bottom windows/red arrows). The percentage of S&P 1500 stocks above the 200-day SMA moved below -45% (but whipsawed). These indicators are part of the S&P 1500 Trend Model and it turned bearish on December 1st. As noted in the Market Regime update today (here), S&P 1500 %Above 200-day SMA surged back above 55% on December 6th and the Composite Breadth Model is back bullish again (green arrow).

What the hell just happened?

Weakness started on Black Friday and continued into the next week, which is when the breadth indicators triggered bearish. This suggested that the Black Friday decline was not a fluke. Even though the Composite Breadth Model turned bearish on December 1st, the S&P 500 Trend Model remained bullish and the 5-day SMA for the S&P 500 remained above the 200-day SMA. Thus, the Composite Breadth Model was net bearish, but the S&P 500 was still holding up.

The S&P 500 is still the elephant in the market and a bear market without the S&P 500 is hard to imagine. Note that a bearish signal in the Composite Breadth Model does not always lead to a bear market or a 20% plus percent decline. A bearish signal in the Composite Breadth Model means risk is above average and picking winners in the stock market is going to get a lot harder.

Even though the evidence favors the bulls still, there are reasons for concern. The bearish breadth thrusts in the S&P 500, S&P MidCap 400 and S&P SmallCap 600 remain in play. I am still seeing deterioration in the percentage of S&P 500 stocks above the 200-day and 150-day SMAs, but have yet to see a bearish signal. Yield spreads surged in November and fell back a little in December, but remain a little elevated. Growth stocks are out of favor right now and IWM remains an underperformer. This reflects a waning risk appetite.

SPY was very oversold on December 1st, sentiment was quite bearish as AAII percent bears exceeded 40% last week and the VIX closed above 30 for the first time since January 2021. This set up the oversold bounce. Despite my concern shown above, this advance could have some short-term legs. The strong readings in Advance-Decline Percent in three of the last four days suggests that this advance could extend to new highs for the S&P 500. The seasonal patterns are also bullish in December.

Other Notes and Charts

QQQ remains a leader because it did not become oversold during the pullback. The ETF fell to broken resistance with a 50% retracement and gapped up on Tuesday. Mind the gap. Dozens of ETFs gapped up on Tuesday and it is important that they hold these gaps because many of these gaps triggered short-term breakouts.

You can learn more about my chart strategy in this article covering the different timeframes, chart settings, StochClose, RSI and StochRSI.

The chart below shows the Russell 2000 ETF (IWM) becoming oversold from November 26th until December 3rd and hitting support. StochRSI popped above .80 on Monday and IWM broke short-term resistance on Tuesday.

The Healthcare SPDR (XLV) was oversold and in the 50-67% retracement zone last week. This is was a potential short-term reversal zone and the ETF broke out on Tuesday. Note that StochRSI popped above .80 on Monday.

The Real Estate SPDR (XLRE) and the Technology SPDR (XLK) are the leading sectors right now because they hit a new 52-week highs (closing basis) on Tuesday. The Utilities SPDR (XLU) is also performing quite well with a gap-surge above the November high.

Thanks for tuning in and have great day!

-Arthur Hill, CMT
Choose a Strategy, Develop a Plan and Follow a Process

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