Some Warning Signs Are Here, Can The Market Recover?

08/21/08 9:30 AM EST

Good Thursday morning...We begin the day with another large gap down in the equity indices as we get a one-two-three punch of lower financials, lower Dollar and higher Oil.  As we went over on Friday, those three sectors/assets are among the highest-correlated to the S&P 500 over the past month. 

We've been stuck in an excruciatingly edgeless environment with regards to the broader equity market over the past couple of weeks.  I've noted often how it's been very difficult to find any consistent bias among our sentiment-, breadth- and price-based guides, and choppy conditions we've seen are not at all unusual within that context.

That's clearly reflected if you take a scroll through the bull/bear icons on the Complete List of indicators or glance at the Indicators At Extremes table on the Daily Overview page.  All of our models - from the shortest- to the longest-term - are neutral, and the Smart Money and Dumb Money Confidence are both exactly flat at 50%.

We can't even rely too heavily any longer on the goodwill that was extended to the bulls on July 15th and in the follow-through during the subsequent trading sessions, as the market has about met its minimum historical obligations after such readings.  A failure here would reflect a weak rally indeed, but we DID rally for about a month and between 5% - 15%, and that's all we can usually ask for during a bear market environment.

Unlike the April/May period, when we had the chance to discuss several indicators and studies that suggested the rally was about to end, we haven't seen much of anything of the sort during this rally.  We went over a couple of potential warning signs yesterday related to the (really obvious) break of the uptrend lines off the July low in the S&P 500 and DJIA, and also the extended period that the STEM.MR Model for the Nasdaq 100 has been oversold.  If we can't rally very soon, then the chances of us building upon the post-July rally don't look good at all.

I've been very inactive trading-wise with the S&P bouncing between 1250ish to 1280ish, and unless the index moves outside of that band, I don't see any edge either on the long or short side given the complete lack of extremes among our indicators and studies.  I've been willing to give the upside the benefit of the doubt for the past month - meaning that I have been less inclined to sell into short-term overbought conditions and more inclined to buy into oversold ones - but an inability to rally here is a definite warning sign given what we went over above.  If the S&P loses that 1250ish level and holds below, then my bullish inclinations will go by the wayside until a better technical picture emerges or we go through the painful process of getting another round of overly pessimistic sentiment extremes.