Trend Persistency - The Opposite Of Last July

03/26/09 9:05 AM EST

Good Thursday morning...We begin the day with some buying pressure in the pre-market futures.  We were up significantly heading into the GDP report, but dipped a bit since the release.

On July 3, 2008, we discussed a topic that we've looked at occasionally over the years in various ways - trend persistency.

The title of that comment was "Persistency of Decline is Not a Good Thing" (boy, was it ever), and suggested that the fact that the McClellan Oscillator had been so oversold for so long was a sign of deep selling pressure that was likely to continue.

The Oscillator, a measure of the momentum of breadth developed by Sherman and Marian McClellan in the 1960's, has been a good way to determine not only overbought and oversold conditions, but also just how eager participants are to buy or sell over an extended time frame.  We show the Oscillator for each of the sector breadth charts on the site.

The reason I bring this up is because the Oscillator for the NYSE has been above +100 for the past 10 trading days.  Because the Oscillator is impacted greatly by the number of issues trading on the NYSE, however, we can't really go back and compare that to historical readings, so we have to adjust for that and use a ratio-adjusted Oscillator.

That Ratio-Adjusted McClellan Oscillator has now been overbought above the 50 level for 9 straight days, and will probably be 10 straight after today unless we really fall apart.

The remarkable thing is that the Oscillator has not had 9 straight days above the 50 level since February 1991 - more than 18 years ago.  It got close in late October 1998 with 8 straight days as we were emerging from the mess that fall, and it got close again with 7 days in June 2004, but it has not been matched since 1991.

That's a streak of 4,334 trading days since the last time we've seen 9 consecutive overbought readings in the Oscillator.  Going back to 1940, the previous longest streak was "only" 1,255 days that ended in September 1945.

The only other time we've seen such persistency when coming out of a deeply oversold reading of -100 or worse during the prior month was November 15, 1962.  This was the climb out of the re-test of the bear-market low in June of that year that we looked at yesterday.

There were 13 times the Oscillator had dropped below -50 during the prior month, then saw the kind of upside persistency we're seeing now.  A year later, the S&P was higher 10 times, with an average of +11.2%.  8 of the 13 showed double-digit gains, compared to the three losses of -3.4%, -3.6% and the major failure of -25.6% (from 1974).

That all looks quite positive, however the one concern I have is the same thing we went over on January 5th of this year - we're now overbought in a downtrend according to the McClellan Oscillator (overbought) and the longer-term Summation Index (downtrend).

The fact that the Summation Index is rising is a positive sign, however it has not been able to make it above the zero line yet this month.

We could make the argument that this time is sufficiently different than last time, because in January the market rolled over quickly after becoming overbought, and we never saw "trend persistence" like we're seeing now.  This time, the Oscillator jumped over +100 on March 18th, and now a week later we're still higher than we were then on the S&P 500.

Bottom line - Intermediate-term

Two weeks ago, we went over a number of indicators and studies that suggested we were very likely within days of an inflection point.  By Tuesday and Wednesday of the week before last, sentiment had reached an extreme (the setup) and the price pattern coincided almost perfectly with past lows (the trigger).

The market failed to follow through immediately, instead continually flirting with that 681 area that marked March 3rd's late afternoon low in the futures.  Despite intraday forays under that level several times, we closed above it every day but March 9th.  This was a messy pattern, but still basically within the confines of the risk parameters mentioned in the past studies.

After March 10th's "blast off" day, we needed to see some short-term follow-through, per the tables from Wednesday and Friday.  We got that in spades, which basically means that it would be unprecedented to not see generally higher prices over the next one to three months, and pretty much everything we've looked at since then helps confirm that outlook.

The short-term prospects have been more difficult to determine.  Last week, especially, the S&P was able to rally better than expected, only temporarily being rejected by resistance levels.  Now we're in a kind of vacuum as far as that goes, with 875ish the next clear area of probable trouble.  The good news is that this rally has now generated several areas of support, layered from 730 through 760.  From here, I'm looking for a broad multi-month trading range to form, bordered between 730ish at worst and 875ish at best, and will be looking to buy/sell anywhere near those respective levels.

Bottom line - Short-term

On Tuesday I mentioned that a day like Monday will trigger all kinds of extreme readings, and we're certainly seeing that according to a number of different guides (such as the 10-day Up Issues Ratio, the Equity Put/Call Ratio and Rydex traders).

That pushed the Short-term Indicator Score outside of its upper trading band, and again the market had trouble sustaining higher prices as a result.  But the two other times that has happened since the low earlier this month, the S&P was bumping up against resistance at the time and the subsequent weakness was quickly reversed.

I don't see that same kind of resistance here, in fact the way I view things I can't really find any kind of confluence until we near 875ish.  I will likely be looking to sell or short should we approach that area into early April - assuming we see a plethora of overbought signals at the time, which should be a given.

Despite a handful of overbought readings, however, most of our indicators were not very stretched after Monday's session and since we weren't really at resistance either I couldn't find a high-probability reason to bet against the rally.  Likewise, I couldn't find any good reason to chase prices higher either, as that's rarely a good idea after a 6% one-day and 21% two-week rally.

During the worst of yesterday's decline, the intraday version of our most sensitive indicators pushed into oversold territory and the indices saw a quick and significant rebound.  It's been a long, long time since we've seen such a positive response almost immediately after becoming even modestly oversold, though it's almost certainly more coincidence than anything. 

There is a slight bullish edge to sessions like yesterday (extreme movement outside the prior day's high and low, with a close > open), but it is very short-term only.  Combined with the still-slightly-oversold short-term guides, we should see a rebound attempt today but we're already seeing that pre-market which isn't much help.  I never like to see a gap up open right at the previous day's high, so that will be the major factor right off the bat today.  Once again, given the size of the gap open (+1.2% at the moment), if we see a higher intraday high after the first hour of trading - especially since it would likely be above the prior days' highs - then the probability of a downside reversal would diminish substantially.

All the best,