Market Internals, Momentum and Sentiment Update

Combining a review of technical analysis of price with an assessment of internal market strength, momentum and sentiment, can help the market technician arrive at a comprehensive and hopefully accurate perspective on the current market trend, price extremes and potential trend changes.

Let's review the S&P500 (SPX) price activity first, then tour various internal market measures to support our perspective on the US equity markets.

As the chart below displays, the S&P500 (SPX) continues in a trading range bound by 1120 at the upper end and 1060 at the lower end, where it has met support three times since the February lows. Positive divergence is seen in a rising MACD (bottom of chart) and RSI (top of chart) crossing above 50. We like to see price exceed its 34-day exponential moving average (it crossed its EMA 34 today), and prefer that its EMA 13 is above its EMA 34. We have not seen that yet, even through the EMA 13 has developed a positive slope.

Delving deeper into the modestly improving performance of SPX, let's review several indicators of internal market strength.  Two indicators of importance include the percentage of stocks trading above their 50-day moving averages (SPXA50R) and the ratio of Point & Figure buy signals (bullish percentage, or BPSPX).  Are these indicators supporting the mildly bullish perspective of the price chart discussed above?

Reviewing the chart below, it is noteworthy that the SPXA50R has settled into a bear market range, but is struggling to break out.  Notice how the lows during the bull trend (March 09-April 10) fell in the 25-40 range, while the lows during the recent downturn (since the April 26 peak) hovered in the single digits. Highs during a bullish uptrend push toward 95, while highs in a downtrend struggle to beat 50 (see green rectangle and red rectangle). Extremes can be found at these levels, typically preceding a shift in direction in the index (note how SPX-- green line --  bounced when the SPXA50R fell to the single digits in early July). According to this indicator, we are not out of the woods yet on SPX, as the SPXA50R is pushing bear market resistance in the 50 area (will it break out?) and the bullish percentage (bottom of chart) still struggles at its lows.

The Advance/Decline ratio (applied to the New York Stock Exchange, or NYA) is tracked to further corroborate confirmation or divergence. In the chart below, note that a 16-period exponential moving average of A/D (A/D it is too erratic to view on a daily close basis) is uptrending while SPX (dotted line) remains range-bound. Its RSI has also surpassed 50 and recently crossed above its EMA 14. A/D readings below 6400 have tended to precede market bounces.

Building upon our advance/decline review, we gain another perspective on internal market strength with the McClellan Oscillator, a momentum indicator applied to the advance/decline statistics.  

The chart below of NYMO (New York Stock Exchange McClellan Oscillator) shows a positive outlook with NYMO crossing up through its 20-day exponential moving average after forming a higher low in early July.  Note the 20-day EMA is on an uptrend (green arrows show NYMO crossing up through its 20-day EMA).

Also included in the chart above is the NYSE Summation Index, which is a longer range cumulative view of the McClellan Oscillator. We have found when the price of this index crosses its 20-day exponential moving average, there tends to be a change in trend. Despite the whipsaws we see in June and July, the indicator upholds a bullish cross and is a positive divergence for the equity markets.

Internal market strength can also be perceived by reviewing Down Volume vs. Up Volume. Again we use the NYSE (NYA) as our proxy for the US equity markets. In the chart below, note that the Down/Up Volume ratio has declined since early June while the SPX has remained in its trading range. A similar downslope can be seen during the SPX uptrend from the Feb lows through late April. Although the SPX has not performed as strongly as the Down/Up volume ratio would suggest, the decline in the ratio is a positive development and lends support to the positive divergences seen in these internal market measures.

Finally, we assess market sentiment and the fear gauge by reviewing VIX and the Put/Call ratio.  Our interest is to identify indicators applied to these measures that can help pinpoint extremes in sentiment and potential changes in trend.

As for VIX, we view VIX with an RSI (14) below 50 as bullish for equities.  In addition, we look for potential market turns by measuring the gap between the closing price of VIX and its 50-day exponential moving average.  The wider the gap, the more likely that a trend change in equities will occur.  Note that wide gaps in early May, early June, late June and early July (see blue rectangles) preceded a bounce in SPX. Today, there is a modest gap (no extreme reading), yet VIX is bullish at an RSI reading of 40.

Put/Call (P/C) is used in conjunction with VIX as our sentiment/fear indicator.  We see value in tracking P/C extremes as well as extremes in its 13-day exponential moving average.  Note the extreme low in P/C and its moving average in mid-April, which preceded the market drop (P/C is used as a contrary indicator). Spikes can be seen near option expiration dates in the 3rd week of April, May and June. A peak of 1.25 in early July signaled a bounce in equities. Per the chart below, P/C is neutral (there is a large neutral zone bound by .80 at a low and 1.0 at a high), and is not signaling an extreme reading.

After assessing the SPX relative to its trendlines and RSI, measurements of internal strength, momentum and sentiment indicators, we can arrive at a perspective on the condition of the US equity markets as represented by SPX.  Based on all of the above, we are mildly bullish, and would hold off on establishing short positions even though the SPX trend remains down (or at best in a trading range). These signs of SPX strength and positive divergence would next compel us to review the various sectors of the S&P500, to identify where pockets of relative strength are surfacing.  While we try not to pick market tops and bottoms, the sentiment and breadth indicators help us to identify potential market extremes, while moving averages and RSI help to confirm trend and validate price action. As always, price action is the number one focus, as we should use technical indicators within the context of the prevailing trend. But don't ignore the value that various indicators convey in pointing out divergences and early warning signs.