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Here’s the Deal:

The S&P 500 traced out an outside down month in July. Typically, an outside down day is a serious sign of a reversal and or important high. So that immediately brings to question, what does an outside down Month mean?

For the S&P 500, starting January 1962, when my readily available data starts, we have seen a total of ten outside down months where the month’s high was also at least a three month high. The following month was a down month only three times. The other seven times the S&P closed higher at the end of the following month. Three months later, the S&P 500 was higher eight of the ten times.

An outside down month is a rare event and generally speaking it is something the bulls would rather avoid. However, of the ten the only one that turned out to be a major high was February 1966. Lower prices followed on a near-term basis, but most of the time they were temporary setbacks within established bull trends. The Outside Down month is worth noticing, but history says it isn’t something we need to be terribly worried about. There are many more important issues to focus on at this time, which should prove much more telling.

The Dow spent the day churning just below Tuesday’s opening high, coiling and building confidence and energy for the next step higher. Late in the day that energy burst lose with the Dow rocketing over 50 points in about a 10 minute time span.
The Dow reached 13,420 early in the day and that signaled a likely move to 13,500, which happened during the late day thrust higher.
From a pattern stand point that leaves us with a small five wave move higher and support at Thursday’s lows. Ideally we will see a mild pullback down near Thursday’s lows and then a larger push higher will develop. Falling back below 13,300 will suggest a much less directional move is developing.

With constructive action on Thursday there is growing confidence the overdue low is finally in place. We are actively watching for a 62% retracement of the move lower, which targets 13,700. While we are looking for higher prices, the expected action should be choppy as was the case on Thursday.

Friday morning we get the employment data. With all the economic carnage discussed in the headlines, seeing a solid employment report will go a long way towards confirming the real US economic strength.  

Here’re the Details:

The Dow was down only 12 points at its 13,350 low. It rallied 150 points to its high of 13,503 before settling to close at 13,463.33 up 101 on the day and 40 points off the high. This is the first two day advance since mid July.

Interest rates drifted a little lower but remain in contact with the 49 support line: Hurry up and wait for the economic data -- that is the best way to describe the bond market Thursday. The report should be solid, the question is, is that good or bad for bonds. After the large flight to quality move, we are expecting rates to work higher with the expectation of the gap left at 50 to be filled in the days / weeks ahead.

S&P 500 is mounting a comeback: Thursday afternoon the SPX jumped 10 points in just 10 minutes. While the entire move was much briefer than Wednesday’s afternoon move, it is clear we have seen late day buying interest, and end of day action is typically more telling that opening action.
The SPX failed to reach the 76% retracement line at 1477.40 on Thursday. It did manage to close above the 62% line at 1470, but just barely. Pushing above 1477 will target 1490 on a near-term basis. Seeing the SPX slide below 1460, Thursday’s lows, will suggest a less directional move is tracing out.

The very short-term cycles on the S&P have finally turned higher. At this point the very short-term cycles are calling for a minimum of another day and a half of positive price action.
The next major turning point for the Bradley indicator, aka, the longer-term cycles, is August 27. There are significant momentum points on the 15^th (peak) and the 21^st (trough.)

The Russell 2000: is rebounding, but so far it isn’t much of a rebound. The initial buying has been concentrated in the heavily traded indices. On the back of a positive Friday, the Russell should be able to reach 795 at which point we will have to re-evaluate.

Crossing points in time: The NASD rallied back to 2575, about where the longer-term uptrend line crosses the near-term down trend line. A powerful thrust above the 2575-2580 resistance area will put to 2600, which is formidable resistance.

With Thursday’s strength, all the daily trends have turned up, and the Dow even managed to squeak out a Daily Buy signal. The 3-day trends can turn up on Friday provided we take out Thursday’s highs, but we must also above Thursday’s lows.  

Detailed Trend Report on Web & CLX Count and Weekly Signal Counts & NYSE & NASD 5-day up and down volume charts

Total breadth was only +1413. That is the best reading we have seen since the massive upward thrust on July 12, but in the grand scheme of things it is a pretty lame reading for 100 point Dow move. The NASD was the lagging area.
Total volume contracted from Wednesday’s climactic reading and was again weighed to the upside. With positive internal action the 5-day metrics are finally coming down off their remarkably extended levels. But overall a significant oversold condition persists.

Normally when the market comes out of an extreme oversold condition as we just saw the move is quick to take on a very directional tone. While we have two rally days in hand, I have to confess that the action has been somewhat unique relative to what a recall as “normal” (if there is such a thing.) The point being, in light of the extreme oversold condition, if we don’t see some really solid internal strength develop within the next few days, we will have confirmation of our longer-term expectations which call for a difficult three months ahead.
Look at it this way, internally speaking, if this is all the bulls can muster; they are in a heap of trouble.

We are now two days into what should be a three to five day rally. If we see an urgency to buy develop, that will set a constructive near-term tone and give the rally effort new life. For now, let’s see if we can get that third day of rally to develop.

Jim Patterson

Most Obvious chart resistance levels: (Gap levels)
Dow  13,350, 13,490, 13,580, 13,630, 13700, 13,775, 13,825, 13,950, 14,030, 14,350
SPX 1475, 1488, 1496, 1505, 1517, 1527, 1535, 1542, 1547, 1555, 1562, 1593, 1613
NASD 2580, 2605, 2629, 2649, 2664, 2680, 2700, 2735, 2745
NDX 1954, 1968, 1988 2000, 2018, 2045, 2056, 2100, 2142
NYSE 9657, 9730, 9860, 9920 10,000, 10,060, 10,150, 10,230, 10266, 10,363
RUT-2K 787, 803, 813, 824, 832, 838, 842, 848, 854-856, 861, 876

Most obvious Chart Support levels:
Dow 13,950, 13,875 13,735, 13,685, 13,605, 13,520, 13,480, 13,350, 13,250, 13,010
SPX 1535, 1526, 1513, 1504, 1496, 1487, 1483, 1475, 1470, 1454, 1441, 1420
NASD 2694, 2680, 2655, 2635, 2614, 2602, 2578, 2562, 2548, 2518, 2455
NDX 2045, 2026, 2014, 2000, 1973, 1965, 1957, 1948, 1943, 1920  
NYSE 10,040, 10,000, 9940-60, 9840, 9800, 9720, 9690, 9585, 9540, 9410, 9350, 9280
RUT-2K 844, 838, 834, 828, 820, 808- 810, 803, 790, 776, 772, 760, 747

Here’s where we are now:

NASD 100 Index (NDX) Trading System, trade the QQQQ:

The NDX reached the 62% line at 1962. It is now up against down-trend resistance at 1970. Cracking 1970 with some authority should target the 1992 to 2000 resistance range.  

S&P 500 (SPX) Trading

We went long the SSO on Wednesday 6/13 on the back of the Rare Buy signals with an entry price of 94.42.   Entry #2 @ 93.00
The SSO closed at 90.27

We are still looking to exit one of the SSO positions at 91.80, unless the internals are really strong. We do have a series of rare buy signals, which are typically seen at important market lows. However, at this point we need to see significant internal improvement to confirm the near-term bottoming potential.

Tactical Stock Trading Powered by Patterson Relative Strength

BBD rec long 5/31 @ 25.39, stop 23, Target 29.5, closed at 26.45
CHINA rec long 6-14 @ 8.56, stop 8.01, closed at 8.66

** PRS Open Actives making noise:
The Table below shows stocks with a 12-month PRS greater than 75, 6-Month PRS of 40 to 60, which means the stock is essentially flat over the past six months, and a 3-month PRS of 70 or higher, meaning the stock has been moving higher over the past few months.
The goal is to find solid stocks that have more of a base like formation over the past six months. Once the market does bottom and turn higher, the best gains will come from stocks that have been building a base formation since the February highs. In essence, since the February 2007 highs we have been in an environment of diminishing returns, with a shrinking number of stocks showing smaller and smaller percentage returns.

Jim Patterson
Editor
Tactical Trading Outlook

Here’s the Deal:

Down 3.1%, that is how much high risk high yield bonds lost in July, their worst month since May 2005. High yield bonds are down about 5% to 7% over the past two months, and the decline has put at least half a dozen “hedge funds” (read: leveraged junk bond fun) out of business, and cause a domino effect of pain through out the financial world. It is amazing the mess that a 3.1% move in one month can cause. Note: the stock market bottomed in April 2005.

The fact prices broke below 13,200 and stalled at 13,150 well above the next line at 13,000 is a notable sign of waning downside momentum.

If the overdue low is in place, a normal 62% retracement will carry the Dow back to 13,700, which is interestingly right in line with the June highs. We are looking for a strong recovery day, but overall the action is expected to be choppy over the next few days.

Economically Thursday is quiet with claims and Factory Orders, which is a volatile series. Then Friday we get Unemployment and non-farm payroll data, which should give the bond market something to chew on.  

Here’re the Details:

The Dow was down 79 at the low of 13,132. It was a choppy range but ultimately, the Dow rallied 260.34 points to its high of 13,393.02 when it was up 181. That is the best up move since July 12. The Dow closed at 13,362 up 150, about 30 points off the high of the day.

Interest rates are stable, possibly ready to step lower: The TYX quickly dropped to the 49.00 level of support. This is also the first Fibonacci downside extension level for the TYX. As stocks begin the recovery process, look for the TYX to attempt to fill the gap it left at the 50.00 level. While the TYX may drift a bit lower, the 49.00 level should act as a short-term floor.

S&P 500 should be sold out: The most remarkable aspect of Wednesday’s action was in overnight trading. The futures traded down almost 20 points overnight before coming back allowing the market to open flat to slightly positive on the day. In a perfect world, the S&P would have gapped 10 points lower on the open and that would have signaled the bottom. However, because prices came back, the S&P had to actually go down and test the overnight level during the trading day. The good news is that at the end of the day, the shorts were officially on the run.
1460-1465 was the critical resistance area to get through and the SPX closed at 1466, the Fibonacci 62% retracement level and just below the key week long down trend line. Closing above 1470 and more importantly, the 76% level at 1477, will indicate a likely rally back to the 1490-1500 level. However, 1490-1500 remain a significant band of resistance and it will take a notable change in character to solidly overcome this resistance level.

The Russell 2000: has not broken its March lows, but it came very close. We now have two downside tails over three days. This suggests increased buying interest and it is clear the rate of decline has slowed. The stage is set for prices to continue their rebound, but unless we see a remarkable change of character, this is going to be a brief rebound.  

The NASD managed to hold the 2525 -2550 support area. While we saw a recovery, the NASD was lagging way behind. It seems the short covering was concentrated in the Dow and S&P 500 rather than in NASD stocks. That said, the same oversold condition persists on the NASD as the other indices and that suggests additional strength to come over the balance of the week. Just keep in mind, for now it is considered a relief rally.

Year 7 Seasonality: Whether the average line for year seven is calculated with or without 1987 is somewhat irrelevant. Hopefully we won’t endure the average 15% to 18% decline from high to low. Then again, the Dow has already corrected 6.3%.

Putting Year 7 into perspective, a look at the Decade:
The chart below is based on the Dow’s price movement in each of the past 10 decades and I find the pattern rather remarkable, particularly the correction that typically takes place in the second half of year 7. The fact current rally is running about 35% below average may soften the expected blow, but seasonally is remarkably stiff through this particular time period.

The rest of the monthly trends turned down on Wednesday and the NYSE daily trend shifted back to a sell signal. We should see all the daily trends turn up on Thursday and the 3-day trends can turn up on Friday. Seeing the 3-day trends turn up will confirm the presence of a near-term low.

Detailed Trend Report on Web & CLX Count and Weekly Signal Counts & NYSE & NASD 5-day up and down volume charts

Total breadth recovered from -3350 at the 2:30 PM low to finish at -1060, about in line with Tuesday. At the afternoon low, total breadth made a lower low while several indices failed to do so. This is viewed as a minor positive divergence. The internals were unable to keep pace with the rapid late day recovery, which is not a significant issue.
Total volume was huge at 3.8 Billion shares. Despite negative breadth, directional volume was weighted to the upside.

The Rare Buy light has finally gone out after six consecutive signals. Technically the first signal closes out on Thursday, and with an entry at 1511, in hind sight, was early. The second signal expires with Monday’s close. Its entry of 1482 may prove successful. The other two expire on 8/7 and 8/9. The main point is that such an excessive condition is coincidental with an important market low.

Unfortunately, as explained last night, when this many signals are given within a four week period, more often than not, additional Rare Buy signals are often given. In short, that means that if we see another round of selling it is likely to be intense. However, once past the first grouping of signals in a cluster, most of the subsequent signals prove profitable.
It is important to note that the only major failure, excluding downside spikes during the 2001 – 2002 bear market, was August 1998 during the LTCM event when there was a long three week pause between the first step lower in late July and the and the final move into low at the end of August.

The 5-day RSI metrics failed to make lower lows with Tuesday’s lower closes.

Overall the market remains near maximum oversold levels. Over the past few years, when an excessive oversold condition was reached, after a three to five day counter-trend move, a second major round of selling took place. For now, that is our bigger picture outlook.

It appears the bounce has finally arrived. Assuming it has, we should see prices chop higher over the next three to five days. The potential recovery period could last as long as three weeks, but in light of the current action, let’s focus on the three to five day time frame for now.  

Jim Patterson

Most Obvious chart resistance levels: (Gap levels)
Dow  13,350, 13,490, 13,580, 13,630, 13700, 13,775, 13,825, 13,950, 14,030, 14,350
SPX 1475, 1485, 1496, 1505, 1517, 1527, 1535, 1542, 1547, 1555, 1562, 1593, 1613
NASD 2580, 2605, 2629, 2649, 2664, 2680, 2700, 2735, 2745
NDX 1954, 1968, 1988 2000, 2018, 2045, 2056, 2100, 2142
NYSE 9657, 9730, 9860, 9920 10,000, 10,060, 10,150, 10,230, 10266, 10,363
RUT-2K 787, 803, 813, 824, 832, 838, 842, 848, 854-856, 861, 876

Most obvious Chart Support levels:
Dow 13,950, 13,875 13,735, 13,685, 13,605, 13,520, 13,480, 13,250, 13,250, 13,010
SPX 1535, 1526, 1513, 1504, 1496, 1487, 1483, 1475, 1468, 1454, 1441, 1420
NASD 2694, 2680, 2655, 2635, 2614, 2602, 2578, 2563, 2548, 2518, 2455
NDX 2045, 2026, 2014, 2000, 1973, 1965, 1957, 1948, 1940, 1920  
NYSE 10,040, 10,000, 9940-60, 9840, 9800, 9720, 9690, 9585, 9510, 9410, 9350, 9280
RUT-2K 844, 838, 834, 828, 820, 808- 810, 803, 790, 781, 772, 760, 747

Here’s where we are now:

NASD 100 Index (NDX) Trading System, trade the QQQQ:

The NDX was one of the weaker indices on Wednesday as it sliced to new lows. However, it should rebound with the general market from its excessive oversold condition. 1962 is a 62% retracement while it will need to better 1975 to signal an attempt at 2000.   

S&P 500 (SPX) Trading

We went long the SSO on Wednesday 6/13 on the back of the Rare Buy signals with an entry price of 94.42.   Entry #2 @ 93.00
The SSO closed at 89.03

If the SSO recovers to 91.80 we will close one of them unless the market is screaming higher. For now we are looking for an exit point and higher prices based on the series of rare buy signals given. However, looking forward odds are we will see additional corrective action in the months ahead and this counter-trend rally should allow us to position for it.

Tactical Stock Trading Powered by Patterson Relative Strength

BBD rec long 5/31 @ 25.39, stop 23, Target 29.5, closed at 26.18
CHINA rec long 6-14 @ 8.56, stop 8.01, closed at 8.77

** PRS Open Actives making noise:
Best of the Best table, stocks with PRS 3, 6, and 12 month rankings of 97 or higher as of Tuesday’s close. Some have held up remarkably well, but most are more than 10% off their highs.

Jim Patterson
Editor
Tactical Trading Outlook