Timing Models – The Only Game in Town, Double-Edged Swords and Some Bearish Breadth Signals

See Saturday’s video post for current ChartBooks.

SPY and QQQ fell in September and are in short-term downtrends, which are considered corrections within a bigger uptrend. The S&P SmallCap 600 SPDR and S&P MidCap 400 SPDR also fell in September, but these declines do not look like mere corrections within a bigger uptrend. MDY, IJR and IWM fell well short of their January-February highs and broke their downward sloping 200-day SMAs. These three look like they are reversing the uptrends that began with the March blast off.

SPY and QQQ are really the only game in town when it comes to market cap. Most stock-related ETFs will follow the lead of these two. The breadth models and indicators are holding up the best for SPY, QQQ and OEF as well. In fact, some short-term breadth indicators in the Nasdaq 100 are looking oversold and this could give way to a bounce. Also consider that we have the turn of the month coming up. This period covers the last four days of one month and the first four days of the next month shows a positive bias.  Currently, this runs from 26-Sept to 6-Oct.  

My base-case is still for a correction that extends into November, but corrections can take many paths. The chart below shows me playing a dangerous game by predicting future price movements in SPY. Notice that a falling wedge formed here in September and RSI is in the 30-40 zone (oversold).  The falling wedge also retraced 50-67% of the June-Sept advance. Both the retracement amount and pattern are typical for corrections. Meanwhile SPY is just above its 200-day, which is slightly rising.

The stage is set for a mean-reversion bounce after this pullback. A wedge break out would reverse the fall and signal the start of a short-term uptrend. Even though this would be bullish, I forecast a move back to the 340-350 area and then another leg lower into October. Should this most subjective forecast pan out, we would then have a classic ABC correction that ends in the 300-310 area. For now, one step at a time: we need some sort of short-term upside catalyst to signal that the September pullback is ending and a short-term uptrend is starting.  

The next chart shows QQQ with a similar scenario. After all, these two are pretty much joined at the hip. Notice that RSI for QQQ is firming in the 40-50 zone and did not break below 40. This shows less downside momentum than SPY on the September decline and this is a sign of relative strength. Also note that several tech-related ETFs held up relatively well the last two weeks (IGV, SOXX, HACK, CIBR, SKYY, CLOU, FINX, IPAY, IBB). Outside of tech, I am seeing short-term relative strength in ITB and XHB.  

Looking at Prior Oversold Zones and Breakouts

A stock or ETF is in a long-term uptrend when the 5-day SMA is above the 200-day SMA. Said stock or ETF is also oversold when RSI(14) moves into the 30-50 zone. The combination of a longer-term uptrend and short-term oversold condition can give way to a mean-reversion bounce. Timing said bounce, however, is not as easy.

The chart below shows instances when SPY is ripe for such a mean-reversion bounce with the green shading. Rarely does such a bounce happen within a few days. Usually, RSI fiddles around in the 30-50 zone for 2-4 weeks before we get a meaningful bounce. The blue lines mark corrections that formed as RSI dipped into the 40-50 zone. The red arrows show when RSI became oversold and price simply fell further, and harder. This is why it is sometimes best to wait for a little upside catalyst, such as a wedge breakout or RSI move above 50. Whatever you do: plan you trade ahead of time and then trade according to that plan.

Medium-term Indicators Turn Seriously Mixed

The medium-term indicators deteriorated again this week with mid-caps and small-caps leading the way lower. The bulk of the evidence is bearish for the S&P SmallCap 600 and S&P MidCap 400. The evidence is mixed for the Nasdaq 100 and S&P 500 as the Bullish Percent Indexes weakened considerably, 20-day High-Low Percent plunged and SPY volatility rose.

The percentage of stocks with silver crosses (20-day EMA above 50-day EMA) continues to deteriorate in all indexes, but the most deterioration can be seen in the S&P MidCap 400 and S&P SmallCap 600. Some 60% of stocks in the Nasdaq 100 and S&P 500 remain with silver crosses, but fewer than 45% of stocks in the S&P MidCap 400 and S&P SmallCap 600 have active silver crosses. This means the 20-day EMA is below the 50-day EMA for the majority of small-caps and mid-caps (the majority of the market).

The next chart shows the percentage of stocks with golden crosses. The NDX and SPX GoldenCross% indicators remain above their 20-day EMAs and we have yet to see deterioration in large-caps stocks. The story is different with mid-caps and small-caps as the GoldenCross% indicators turned down and broke their 20-day EMAs for the first time since May.

Ditto for the High-Low Lines. The High-Low Lines for the Nasdaq 100 and S&P 500 are still rising (above their 10-day EMAs), but the High-Low Lines for the S&P MidCap 400 and S&P SmallCap 600 turned down (below their 10-day EMAs).

Two of the three BPIs remain bullish, but this may not last long. With the decline since early September, the OEX BPI moved to its lowest level since late March (40%). The NDX BPI already triggered bearish with a move below 40% and OEX would likely trigger with more weakness today or Monday. SPX BPI is just above 40% and also close to triggering bearish.

20-day High-Low Percent Whipsawed and moved back below -10% on Monday. In fact, the indicator exceeded -40% this week as we saw a surge in the percentage of S&P 500 stocks recording 20-day lows. This is the highest percentage of 20-day lows since March and shows a significant uptick in downside participation.

I am showing a simpler version of the indicator for volatility today. Normalized ATR(2) is 2-period ATR divided by a 2-day SMA of the Close. This division step normalizes ATR so we can compare across periods and price ranges. Daily volatility started picking up on 3-Sept as Normalized ATR(2) poked its head above 2 for the first time since July 15th. There have been several moves above 2 since and the 20-day SMA of Normalized ATR turned up. High and rising volatility is normally associated with price weakness.

Breadth Models Unchanged, but 3 Bearish Signals Trigger

There are no new signals from the breadth models, but we did see some new signals in individual indicators over the past week. Four of the five long-term breadth models are net bullish. The S&P SmallCap 600 is the only model still bearish (since late February). In addition, the five bearish indicator signals are concentrated in the S&P MidCap 400 and S&P SmallCap 600.

Long-term Breadth Models

  • – S&P 500: bullish since 23-Jul
  • – Nasdaq 100: bullish since 18-May
  • – S&P 100: bullish since 2-Jul
  • – S&P MidCap 400: bullish since 10-Aug
  • – S&P SmallCap 600: bearish since 25-Feb

Short-term Breadth Models

  • – S&P 500: bullish since 23-Jul
  • – Nasdaq 100: bullish since 29-Apr
  • – S&P 100: bullish since 26-May
  • – S&P MidCap 400: bullish since 9-Apr
  • – S&P SmallCap 600: bullish since 9-Apr

As noted before, we did see deterioration in the long-term breadth indicators recently. The percentage of S&P 500 stocks getting above their 200-day SMAs did not surpass 65% in August-September. In contrast, this indicator was above 70% many times from September 2019 to February 2020. This shows less upside participation than before.

Currently, almost half of the stocks in the S&P 500 and S&P 100 are below their 200-day SMAs. More than 65% of stocks in the S&P MidCap 400 and S&P SmallCap 600 are below their 200-day SMAs. There are pockets of strength in large-caps, but also some big pockets of weakness. Percent above 200-day SMA: SPX 51.1%, OEX 52%, NDX 73%, MID 36.3% and SML 33.1%.

All five short-term breadth models are net bullish, but three bearish signals triggered this week. Namely, %Above 20-day SMA moved below 10% for the S&P 500, S&P 100 and S&P MidCap 400. This means more than 90% of stocks in these indexes moved below their 20-day SMAs. The other two indicators in these short-term models are on bullish signals and this means the models are still net bullish.

Short-term Breadth Oversold for Nasdaq 100

I suspect that bullish breadth thrust signals are more reliable than bearish breadth thrust signals and the short-term models are better at identifying bottoms, as opposed to tops. First, the stock market does have a long-term bullish bias. Second, a bearish breadth thrust presents traders with a double-edge sword. In fact, many indicators present us two-handed arguments. A bearish breadth thrust shows broad downside participation and also creates short-term oversold conditions. Broad downside participation can foreshadow the start of a downtrend, but the oversold conditions pave the way for a bounce.

Think of it as a boat full of people (stocks). The boat tilts when everybody moves to one side (<20-day SMA). When enough people move to one side, the boat tilts far enough to capsize. However, as the boat starts tilting, more people (stocks) move to the other side (>20-day SMA). As still more people move, this causes the boat to tilt back and this is the mean-reversion bounce. So, the question is: does the market capsize or tilt the other way?

The Nasdaq 100 is the only index where all breadth indicators are on bullish signals and the strongest of the five. Nasdaq 100 %Above 50-day SMA hit its lowest level since April (~12%) and %Above 20-day SMA hit its lowest level since late March (~22%). Neither indicator, however, has yet to trigger bearish. These low readings point to an oversold condition in the Nasdaq 100 and this could lead to a bounce.

S&P 500 %Above 20-day SMA crossed below 10% on 23-Sept to trigger bearish. This signal is a sort of breadth thrust that shows broad downside participation during the recent decline. The other two indicators are still on bullish signals: %Above 50-day SMA and 10-day SMA of Advance-Decline Percent. This means the model is still net bullish.

S&P 100 %Above 20-day SMA moved below 10% on 24-Sept to trigger bearish. The other two indicators are still on bullish signals: %Above 50-day SMA and 10-day SMA of Advance-Decline Percent. This means the model is still net bullish.

You can learn more about the breadth model and its historical performance in this article and video (here).

One New Bearish Signal in Sector Breadth Model

The Finance SPDR (XLF) was hit with broad selling pressure this week and the 10-day EMA of Advance-Decline Percent plunged below -30% for a bearish breadth thrust. This is really a moot signal because two of the three indicators were already on bearish signals and XLF was the second weakest sector (XLE is the weakest).

There is still quite a smattering of red in this model, but most of the red is in the lower half (smaller sectors). The four largest sectors remain fully bullish because all three indicators are on active bullish signals. Technology, Communication Services and Healthcare have been net bullish since April-May. The trouble does not start for the S&P 500 until we start to see bearish signals triggering in these big sectors.

Yield Spreads and the Fed Balance Sheet

The AAA bond spreads, which represent the highest rated corporate bonds, fell until June and then leveled out at normal levels (below pre-crisis highs). The blue line shows the January 2019 high and a move above this level would be negative. It is hard to say at what level the bond market becomes spooked, but I think a move above 1 would show stress in the bond market and be bearish for stocks. A move above 2 in the BBB spreads would be bearish for stocks.

BBB bonds are the lowest rated of the investment grade bonds and more sensitive to credit/economic conditions than AAA bonds. That is why the Fed was buying BBBs. Junk bonds are even more sensitive and the junk bond spreads ticked higher in September as the High-Yield Bond ETF (HYG) moved lower. The junk bond spread is near its pre-crisis high and we are seeing a little more stress at the junk end of the bond market. A move above 6 would show some serious stress and be bearish for stocks.

The Fed balance sheet continues to inch higher. As the green shading shows, the balance sheet began expanding again in mid July and continues to expand at a modest rate.  

Thanks for tuning in and happy Friday!

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

Scroll to Top