McMillan

Stock Market

This is turning into a very nasty October. $SPX has broken down through all support levels so far: 1220, 1200, 1190, and has now closed at a new relative low -- breaking down below the lows of last week. We had previously mentioned targets of 1170 and 1140, the first of which has now been attained. The target of 1140 still appears attainable on the downside.

Breadth has been terrible. These very negative breadth statistics show how severe the decline has been in the small-cap indices -- the ones with the most stocks in them. They have fared far worse than $SPX or $DJX.

Similar readings are now being achieved in the equity-only put-call ratios. The standard ratio reached 95 on Wednesday (just the single-day reading, not the moving average), which is extremely high. In general, when the ratio hits 100, it is often considered so oversold that it signals a short-term rally is imminent (the WEIGHTED ratio, which is always more extreme, registered a single day reading of 137 -- its highest since
April).

Volatility ($VIX) made a new high as well, but it is not showing the extremes in emotion that breadth and put-call ratios have. It is above 16, though, for the first time since May.

Deeply oversold markets are tricky because they are so volatile that they can cause consternation for both bulls (during market declines) and for bears (during sharp reflex rallies). At this point, though, things have deteriorated so badly that any rally that materializes will surely not last; there will have to be something of a retest before any true bottom sets up. Having said that, a rally can still be substantial -- just short-lived.

One other point: usually at a trading bottom, the market opens down on the day, plunges dramatically in the morning, and then has a sharp upward reversal sometime near mid-day or early afternoon. This particular market has been opening higher each day, and then selling off badly in the late afternoon. That is bearish action. One of these days, though, S&P futures will be down substantially (say, 10 or more) and then rally strongly at mid-day, closing on the upside. That will start the short-term rally. It probably wouldn't carry even to the 20-day moving average however, before retracing and retesting the bottom once again. A successful retest would then signal a more lasting bottom.