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If Selling Dries Up, We Could Have a Christmas Rally

Until the selling pressure eases, it's hard to imagine a market rally.

The Market

Note: Due to some travel this weekend today’s Top Stocks is a shortened version. The regular format will return Monday evening.

Perhaps it was the options expiration, or maybe it was the year-end rebalancing that occurred on Friday, but whatever it was, Friday’s action was more similar to Thursday’s action than it was to what we have seen for the last six or seven weeks.

In early November, we saw the indexes maintain their lofty levels while breadth began to deteriorate. The deterioration was slow at first, but within a week the deterioration had really picked up. At the time, I indicated that while the S&P 500 was at new highs, breadth was not only not keeping up but was heading lower. Even on Nasdaq, where I tend to prefer up minus down volume, the breadth had deteriorated, which was unusual since for the majority of 2021 that was not the case.

The advance/decline line fell and more importantly the number of stocks making new lows began expanding. By Nov. 11 Nasdaq already had over 150 new lows while the index was at all time highs. Even up volume was still twice that of down volume, but underneath the surface we could see the problems developing with the new lows. One week later on Nov. 18, a day Nasdaq gained 72 points on the day, there was already just over 400 new lows on that exchange. We witnessed this for the remainder of November as new lows expanded, new highs contracted and Nasdaq finally corrected nearly 7% to an intraday low of 14,930. The peak number of stocks making new lows on Nasdaq (at least for now) was 732 on Dec. 3.

That’s when the correction ended and we were rallying again. New lows began to contract, the first time in nearly a month. On Friday, Nasdaq on an intraday basis came down to 14,960, almost a roundtrip back to the early December lows. There were 438 new lows, approximately 300 fewer than we saw the last time Nasdaq was down here.

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What that means is that for the last two days we have seen some of the selling pressure that was ever present for the last month and a half ease. Remember, what we want to see is a lower low (preferably) in the indexes and fewer stocks making new lows because until the selling pressure eases it’s hard to imagine a market rally.

Let’s get back to breadth for a minute. In mid November, I highlighted the divergence where cumulative volume on Nasdaq (up minus down) was making lower highs and lower lows while Nasdaq was making higher highs (red line). Now look at late last week and note that (for now) Nasdaq is trying to make a lower low while the cumulative volume is at a higher low (green line).

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I believe this is the early sign of selling drying up in the stocks that have been down (the troops) and it is moving to what has stayed up (the generals). What I believe is still missing is a lower low in the indexes that proves the selling is drying up, with more positive divergences such as this, as well as panicky day in the market. That is what I would like to see early this week because if we see that, I think we set up for a Christmas rally.

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