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Where Do We Go From the Correction?

Let’s take a look under the hood at the indicators to what might play out next.

The Market

Sometimes it is helpful to begin with a review of how we got where we are in the market, so that we may see how it plays out going forward.

In November and December, both the Banks and the PHLX Semiconductor Sector (SOX:Nasdaq) began underperforming. The Bank Index relative to the S&P 500 and the SOX relative to the Nasdaq both turned down. As we turned the calendar to 2020, bonds began lifting, while economically sensitive stocks began falling.

Just over two weeks ago, we began to see divergences in the market. The breadth, while not terribly negative, was starting to struggle to keep up. The McClellan Summation Index began rolling over. The number of stocks making new lows began to rise, while the new highs contracted.

The Russell 2000 peaked and started down, as well. The Transports and the Russell 2000 were never able to surpass their October 2018 highs. And the laundry list of why we should ignore their stall grew. As I am fond of saying, never rationalize an indicator.

Two weeks ago the Dow Jones industrial average got intermediate-term overbought. Two weeks ago the Volume Indicator was at 55%, an overbought level. Two weeks ago the 30-day moving average of the advance/decline line reached an overbought reading.

Several weeks ago, the put/call ratios began giving low readings daily, not just here and there. This took all the various moving average lines down to extreme low readings. Two weeks ago the Citi Panic/Euphoria Model pushed to Euphoria for the first time since April. Two weeks ago, the Investor’s Intelligence bulls got to 59.8%. The American Association of Individual Investors four-week moving average of bears troughed and began to turn up.

Two weeks ago, we were getting Daily Sentiment Indicator (DSI) readings over 90 every few days. The five-day moving average for the Volatility Index’s DSI was under 15.

And now we finally got the correction.

There are several indicators I look toward when searching for the end of a correction or a decline. Getting short-term oversold is the first step in the process. Getting short- term oversold is not the same as intermediate-term oversold; that takes longer. Often it requires a bounce and another trip back down.

Fewer stocks making new lows is also important to me. It shows the selling is drying up. For example, it may still be too soon, but the banks saw very little selling on Friday relatively speaking. Sure it may be that they are down so much already, but who cares why? We care that at some point the down-and-out groups make a stand. That’s how you get fewer new lows.

On the sentiment front, panic is preferred by me. It’s a lot easier to buy if you don’t still own, because it means you have cash. If we have seen panic in the market, often resistance overhead is not terribly strong, because the panic selling cleaned it out.

Panic comes in many forms. One is when the VIX gets jumpy, it is finally getting closer. Another is when the various surveys see bulls back off and bears rise. Last week we saw the Investor’s Intelligence bulls fall to 52%. I fully expect they will be in the 40s this week. Remember, they were kissing 60% two weeks ago. The AAII survey also saw a big change when bulls backed off by 13 points and bears rose by 12. If we don’t bounce strongly before Tuesday, it is likely we see that back off more this coming week.

The DSI is already down to 51 for the S&P 500 and 52 for Nasdaq. So while there is no fear or panic in the numbers yet, there is surely no more complacency.

The put/call ratio remains a fascination for me. In prior declines it would have gone over 100% in a heartbeat. Now we have had three such triple-digit readings in the last two weeks. That’s it. The good news is that the equity put/call ratio was 74% on Friday and it has finally gotten the 10-day moving average heading up. I think it needs to be higher but I can finally say we’re on our way.

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When I look at the short-term, I can see an oversold condition developing early to midweek this coming week. You see, if I walk Nasdaq down an aditional 200 points in the coming week, the Nasdaq Momentum Indicator stops going down and turns up on Wednesday. When momentum refuses to keep going down but the index does, it means we’re oversold.

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It will take a net differential of positive 3,400 advancers minus decliners to halt the decline of the McClellan Summation Index. That puts it in oversold territory. Over positive 4,000, and it’s gotten to an extreme oversold reading.

The Volume Indicator, which was 55% two weeks ago has already come down to 49%. The low 40s is very oversold. Mid-40s is oversold. This is the only intermediate-term indicator that is close to being oversold, though.

The 30-day moving average of the advance/decline line is still weeks away from an oversold condition. And quite frankly my guess is it will take weeks for that Citi Panic/Euphoria Model to move. It is still in Euphoria.

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In sum, I think we can get a short-term oversold bounce by midweek this week, but on an intermediate-term basis, we are likely to come back down after that.

New Ideas

I am going to continue paying close attention to the banks, because if they can’t make a stand soon that will tell us something. Bank of America (BAC) - Get Free Report should hold this $32 area.

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I suspect before this decline has run its course Apple (AAPL:Nasdaq) will tag this line which his $290-$295. The area is so wide, because the line is rising, so by midweek it will be closer to $295, whereas on Monday it’s closer to $290.

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Today’s Indicator

The new lows continue to expand, although not as much as they did earlier in the week.

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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.

Canada Goose (GOOS) - Get Free Report has a measured target at $28 and another at $24. And that looks like a fresh break on Friday. I’d sell a rally back to $32. Alternately if it plunged toward $24 I might be interested in trying to catch a falling knife for a trade.

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I have been willing to give Boeing (BA) - Get Free Report the benefit of the doubt on each push lower, because lately everyone seemed to turn sour on it. Now I say if it can’t get over $330 it’s in trouble.

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FedEx (FDX) - Get Free Report is a tough one for me, because we had a nice trade in December until the time it filled the gap, but now it’s in the middle of nowhere. I suspect it will come down and tag that line, which is heading down so it goes lower as time goes on. For now it’s around $140.

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