A short-term correction looks increasingly likely as bears gain edge over bulls

For the past two weeks the S&P 500, together with other major market indices has been treading water just shy of its all-time highs as the bulls and bears battle for control. Now however, it looks as though the bears have gained the upper hand, something which makes a short-term correction increasingly likely.

In a recent interview Richard Dickson, Senior Market Strategist at Lowry’s, described the market as in a state of “limbo”. He noted that in just the past week we have seen two 90% down days, and that, “90% down days that tend to come up after you’ve had an extended rally, usually are not a real good sign, and show that prices have gotten high enough to really generate some strong selling – profit taking if you will.”

He went on to say that these two 90% down days were immediately followed by two 80% up days, and although they did not qualify as 90% up days, they did “represent a renewed burst of buying enthusiasm”. So over the last week “we have had something for both the bulls and for the bears”. Overall however, the bears have the edge and as Dickson points out, “the onus right now is on the bulls to show that yesterday [Friday] for example represented something sustainable rather than a brief burst of buying”.

A 6 month daily chart of the S&P 500 (Click on the chart for a larger version)

A 6 month daily chart of the S&P 500 (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

The concept of 90% days, which are one of the unique elements to Lowry’s market analysis, was originally introduced by Paul Desmond, President of Lowry Research and the Dean of Supply/Demand analysis. A 90% up day is a day in which up volume represents 90% or more of the total up and down volume for the day. In order to qualify as a 90% up day, 90% or more of the points gained or lost during the day must also be to the upside.

Signs of deterioration

Lowry’s follows many short-term market indicators such as 30-day moving averages of up volume, 30-day moving averages of points gained, the percentage of stocks above their 10-day moving average, and their short-term index which measures demand. Dickson notes that all of these short-term indicators are “showing weakness right now”. In particular the short-term index is “only a few points off its lowest level since last December, even though the market is obviously well above where it was back in December”.

Since the beginning of February the market has been showing signs of what Dickson refers to as “deterioration”, and in the near-term he expects to see a correction. However, once the correction is behind us, he believes the market will put in a strong advance.

The bottom line

Dickson sums up his view by saying that “anyone looking at the market right now, I would certainly not be chasing anything. If I had stocks that were really extended I would probably take some money off the table, and if I were doing any new buying I would be looking for things that are close to levels of support, so that if we do get a pullback in the market your downside risk should be limited, or there should be areas where you could do new buying where there has been significant buying in the past. If we do get a pullback we regard that as a buying opportunity.”

Although they are cautious in the short-term, over the long-term Lowry’s are bullish on stocks. It’s worth noting however, that they are bearish on bonds and see a big risk for those holding bond funds as interest rates begin to rise.

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