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Seeds for a Rally Are Here

Sentiment is too bearish on the whole, we are oversold, and the number of stocks making new lows has been contracting.

The Market

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Over the last week or so I have been asked to update where I think we are on the Sentiment Cycle chart. I have spent a great deal of time considering this because as you know by almost any sentiment metric folks are simply too bearish.

The flip side of the coin is that there are no bases on the charts. Bases take a long time to build. They require months, sometimes years, of sideways action. For quite some time last spring, I thought we were in that area just to the right of ‘Buy the dip’ and that the spring lows (May/June) were in the Panic (May) and Discouragement (June) part of the cycle. That made the summer rally that Wall of Worry. That would make this leg down Aversion.

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I think when it comes to the professional investor, we could be in the Aversion part of the cycle or perhaps Discouragement (because of the lack of bases). And that would be in keeping with my view that we are (at best) in for a long slog of sideways.

However the more I consider it, I think the average retail investor is in that spot where the pros were last spring (to the right of ‘Buy the dip’). I suspect the average buy and hold investor is concerned but not panicked (stocks always come back is the thinking). The reason I say this is because the big cap Hidey Holes have been holding up until recently. Let’s take a look at a chart like Apple (AAPL: Nasdaq), where I was clearly wrong to think it could recapture $150 once it broke. That doesn’t look like it has hit panic yet to me. It looks to me as if it is still where the market as a whole was last spring (to the right of ‘Buy the dip’). The chart should rally off $130-$135.

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I have not been a fan of Microsoft (MSFT: Nasdaq) for at least six months now but Alphabet (GOOGL:Nasdaq) isn’t much different (also not a fan of the chart). Doesn’t that look like it has just completed that section to the right of ‘buy the dip’ and is heading into Panic?

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I guess my point in this exercise is that the index moving stocks are in a much different place than the market as a whole.

We see that in the number of stocks making new lows. They have continued to contract on each push lower in the market. Nasdaq’s new lows on Friday were less than half of what they were a week ago. And they are less than a third of what they were in May.

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There was a time when all you needed to do was own the Invesco QQQ Trust (QQQ) or something close to that, some big cap index that owned all those big cap names, but look at the chart of the iShares Russell 2000 ETF (IWM) relative to the QQQs. It made its low in February this year. It is also on the verge of breaking out to an 18 month high.

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Something else curious is that if we look at small caps alone and look at growth vs. value, using iShares Russell 2000 Growth (IWO) to iShares Russell 2000 Value (IWN) we see growth has outperformed value since the spring, having been the other way around since November 2021.

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Now let’s go back to the chart that I showed here on the first day of 2022, the S&P 500 relative to Nasdaq. I have used this as a proxy for the willingness of investors to take on risk. Starting in 2019 it was a one way trip where Nasdaq (higher risk) outperformed the S&P. Look at that decline where you can barely see the covid decline in March 2020 on the chart. It looks like a blip.

The low for this ratio was in early 2021 (the point I think the bear market began). On the first day of 2022, I drew in that blue line and said crossing this line means 2022 should see more volatility as folks are gravitating to the safety of safer S&P stocks (less risky stocks).

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But notice that this ratio peaked in May for the time being. It is also (for now) making a lower high.

Now let’s zoom in and relate it to the market swings we’ve seen. The arrow on the left is the November high in Nasdaq. Remember when this rises it means folks want less risk in the market so lows in this ratio are generally market bearish. It peaked in mid March (remember that violent rally in late March, into early April). But bottomed again (middle arrow) in early April and the market went down.

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You can see the late May peak and the lower high in June in the ratio. That was the May/June bottom. Now look at the third arrow on the right in early August. That was the peak for the summer rally which I noted at the time was one of my reasons for thinking we’d have more volatility come late August/September. And now we have a lower high.

I think the seeds for a rally are here. Sentiment is too bearish (on the whole), we are oversold, and the number of stocks making new lows has been contracting. But even if the professional investor is at Discouragement or even further along, at Aversion, there are still too many over-owned names that are not. Yet I don’t think we can get this rally if they don’t participate (they should).

New Ideas

Let’s revisit the chart of Alphabet again. It is filling a gap from early 2021 (means should rally). Those blue lines represent the top it broke down from this spring. It measured to around $100. The May low got very close to that level and enjoyed a bounce up to the $120 area in August. Now the black lines represent the next part of the top that it broke down from and that measures to around $90. This is not an exact science but I really would expect Alphabet to rally from this low $90s area. I would expect that the $105-$110 area will be resistance. I would be a seller there.

Today’s Indicator

The new lows are discussed above, along with the chart.

Q&A/Reader’s Feedback

Helene welcomes your questions about Top Stocks and her charting strategy and techniques. Please send an email directly to Helene with your questions. However, please remember that TheStreet.com Top Stocks is not intended to provide personalized investment advice. Email Helene here.

When I was asked about Wolverine World Wide (WWW) - Get Free Report it was like a blast from the past because I think I owned this stock in the 1980s or early 90s and hadn’t looked at it since! I can measure a downside target of around $11-$12 on this chart, so I am a seller on a rally back to $18.

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TuSimple (TSP:Nasdaq) has been going sideways since the spring but that’s the best we can say about it. The stock hasn’t made a higher high in a year. For now I’d say the best we can expect is that it stays in this range between $7 and $10. But if it breaks under $7- ish I would not hang around to see if it can get better.

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Hydrogen ETF HYDR (there is obviously an ETF for everything now!) Even if it recaptures 12 in the coming weeks, it’s a chart in a downtrend that is more likely than not going sideways as best or lower.

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