Reaching Oversold but Without Emotion

Submitted by Mark Hanna

Courtesy of MarketMontage. View original post here.

I keep harping on this “emotion” aspect of the selloff – there has been really none to it, as the selling has been orderly if persistent.   Except for a few sessions losses have been quite contained at the index level even though a lot of individual equities have been hammered tremendously.  In a way this is the opposite of when a healthy market sees sector rotation – one group rallies, then rests, and another takes the baton and so on.  The same has been happening but to the downside.   Need there be an “emotional” type of “pukey” selling to mark at least a short term bottom?  Nope, but it would make it easier to identify a short term reversal.

With all that said we are now seeing some substantial oversold readings in some supporting indicators.  That need not mean things cannot get more oversold – it just serves as a warning that a sharp short term reversal can happen anytime.   That said the action yesterday was just as bad as Friday’s when a sharp intraday rally was decimated – at least Friday’s could be blamed on the speech by Obama, whereas yesterday’s was just out of the blue.  It remains an environment only for daytraders or those with multi year viewpoints.

This morning we open to (wait for it) futures up.  This after what is called a bearish engulfing “candle” yesterday on the S&P 500 chart.  Ironically just hours before the close it was a bullish engulfing candle but that is how quickly this market is moving.  Engulfing simply means the entire previous day’s range was surpassed…

At this point we seem to be creating a new bear flag – as I wrote entering this week the bulls do not want to see sideways consolidation action down here but that is what appears to be happening.

Here are a few of the indicators showing levels of oversold on long term time frames:

Percent of S&P 500 stocks over 50 day moving average – during the 2010 and 2011 euro crisis flare ups these reached super extremes; if you exclude those any reading in the 20-30% range would be considered oversold.  It is now just below 30. (again it can get worse)

NYSE McClellan Oscillator – since the Draghi “whatever it takes” bottom in late July any reading near -40 was a buyable event.  Of course it can get to -60 to -80, and in a few extreme cases >-100.

Other items such as the VIX (use with salt) and put call ratios also don’t show super bearishness here as a strange calm has characterized the selling.

This is why an “emotional” purging from here would give some clarification.   It would take these oversold readings to extreme levels and offer some kindling for an oversold bounce that even bears want at this point.  Instead we get the drip drip drip with continuous morning gap ups that only are faded.  Of course outside of those playing a short term bounce, there is little positive here in the market as the intermediate outlook has darkened technically.

Overnight Europe reported some awful factory order data, whereas Cisco reported decent earnings (via price cuts and cost cutting) yesterday after the bell which seem to be the reason for this morning’s bounce.  Keep in mind we have the FOMC minutes this afternoon – while most would expect some language about new expansion plans to replace the expiring Operation Twist (otherwise the Fed believes it would be “tightening”), the market reaction when that is announced will be interesting.  Especially in light of a market that has been selling off constantly since QEInfinity was announced.  Will the typical Pavlovian response show up yet again today or have people finally learned a lesson?  As an aside, potential future Fed head Janet Yellen was on the wires yesterday talking about easy policy out to 2016… frankly it looks like we’re simply Japan-ized at this point and we might as well make it a full decade (2018) of zero rates.

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