A Will Robinson Moment

This is a work in process and will have much more to come over the next few days. To kick this off, we begin with some technical momentum indicators, indicators that are very strongly calling for a market turn lower.

Indicator reference sheet and market direction assessment

TECHNICAL

1. DJIA 3% Data: I measure the magnitude and duration of changes in the DJIA when there is at least a 3% change in the index. Currently the DJIA is in an uptrend period. The current movement since the last 3% decline shows a positive Return of 10.13% as compared to the historic average of 9.0%. The time period over which this 10.13% increase has occurred is 5 weeks as compared to the historic 8.8 week average for up periods. This indicates we may be in the late stage of a rally, as this move came off of a 3.73% decline with a duration of 11 weeks, so the up-market was not recovering from a deeply oversold condition that might support a much higher up period beyond the historic average.

2. OTC 3% Data: Currently in an uptrend period. Return is 7.79% vs historic average of 12.50%. Time covered is 5 weeks vs 10.6 week average for up periods. Indicates we may have more to rally. The move higher follows a 5.07% decline (below historic decline average of 9.3%) that took 5 weeks (equal to historic avg). Similar to the DJIA, the market was not rebounding off of a deep oversold condition, so this move higher may run out of gas over the near term.

3. Weekly Relative Strength variances from the Mean indicate an overbought condition:

a. Over the next six weeks, absent new point gains or losses of a material nature, the RS indicators will not move in any notable way. The net weekly up and down changes that will roll off net to zero, with no individual week containing greater than 140 DJIA points.
b. DJIA: We are at extreme levels in the twelve-week RS Up measure and in the RS Sum measure. Both are more than 1 Standard Deviation from the historic mean and absent a meaningful move down, the RS will not change materially.
i. The RS Up indicator resides at 2,076. Levels above 2,000 have occurred 51 times since 2007, a 10% occurrence rate. One Standard Deviation indicating an overbought condition occurs at the 1,818 level. At this time, we are 1.56 SDs away from the mean.
ii. The RS Sum indicator resides at 1,633. Levels above 1,600 have only occurred six (6) times since 2007, a 1% occurrence rate. One Standard Deviation indicating an overbought condition occurs at the 999 level. We are presently 1.88 SDs away from the mean. For the six times in the past ten years where we have been this extended to the upside, within approximately four weeks, five of those periods experienced declines in the 400 to 500 DJIA point area.
iii. The 12 week RS Down indicator currently resides at -443. This is one SD away from the mean and further indicates a condition that is unbalanced given the lack of normal swings in weekly market activity. History has indicated that declines after reaching levels near the -440 area range between 500 and +1,000 negative points over the ensuing 12 weeks.

c. NASDAQ: This index is not as overbought as the DJIA. The RS Sum and Down indicators are mildly overbought, and do not indicate extreme levels at this date. The RS Up indicator does reflect an extreme condition that is 1.72 Standard Deviations away from the Up mean, and is by itself a cautionary indication. There is no appreciable impact over the next six weeks from the rolling off of prior periods, so the current condition will not change absent appreciable point moves in the coming weeks.

4. Relative Strength Oscillators that measure turning points in the market indicate the following:

a. For the DJIA, given its relative stability vs the NASDAQ in terms of volatility, a comparison of the 4-week average and 12 week average volatility has proven to be a quality metric in predicting market turning points.
i. Presently, the RS down measure equals a value of 20 within the defined range of 0 to 100. A measure between 0 and 20 indicates an extreme overbought condition. A measure between 80 and 100 indicates an extreme oversold condition.
ii. The RS Up measure equals a value of 97 within the defined range of 1 to 100. This level strongly indicates an index decline is relatively close in time.

b. For the NASDAQ, the greater volatility requires a longer measurement period to generate a more reliable indicator. Here we utilize a comparison of 4 week changes against 16 week changes in the NASDAQ Relative strength index. The activity and high volatility that has taken place over the past five weeks has placed both the RS Up and RS Down measures at or close to turning points. The RS Down measure is 96 and the RS Up measure is at 75. The only trend change we see is the beginning of a turn to the downside for the RS Down measure, and a continued acceleration to the upside for the RS Up measure. This indicator implies that more time will be needed before a reliable turning point arrives.

5. Daily Factors that contribute to the timing decision of the market continuing or changing its direction, include the following:

a. Daily Volume: The comparison of magnitude of the market point changes to the changes in market share volume often highlight internal support or lack of support for the movement in share prices. Presently, the Volume measure has been exhibiting a declining level of positive volume given the point increase in the stock indexes. Over the last 26 days the DJIA has increased by 2,000 points while the volume point relationship has declined from .90 volume per point to .85 volume per point over the 26 day period of the current market rally. This indicates a weak level of support for the index move higher.

b. Daily Issues: Consistent with the discussion above, and even more pronounced is the relationship of issues advancing versus index point changes. Here the relationship over the same 26-day period has moved from 3.02 to 2.59 which indicates a declining level of participation by the broader market in the index advance. Every time over the past three years, when this indicator has reached the 2.65 level or lower the market has reversed from a high point, typically experiencing DJIA declines of 500 to 2,000 points over the next 20 to 30 days post reaching the 2.65 level.

c. Volume and Issues in a combined comparison for advancing components and separately for declining components indicate a lower level of support behind the index advance. The advancing components are rising but have not attained levels that would be consistent with the magnitude of the index increase. The declining components are falling, but similar to the advancing observation, they have not fallen to levels that would historically be present in an advance of the magnitude we have experiences over the past 26 days.
The above factors do not provide a sense of immediate urgency in regard to a reversal being imminent. That is not to say that the market will not fall in the near-term (month of December), it very well may decline precipitously, however it does indicate that the advance is not well supported, which raises the risk of a material decline within the next eight weeks, if not sooner.

Author: Thomas Connolly

Tom possesses a rich and diverse background that includes deep investing experience, senior corporate executive positions, and roles as a Regional Managing Partner and Global Industry Leader within Ernst & Young. He has advised executives on some of the largest acquisitions and dispositions in the Media and Entertainment industry, including clients such as Comcast, Citibank, Sony, Dalian Wanda and Publicis. Tom is a Certified Public Accountant with a Masters Degree from Columbia University. His skills are further accompanied by a personal passion for the study of economic trends and evolving market dynamics.

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