A Rally Like October 2011?

The stock market, in a record-breaking year for market volatility, exceeded the wildest expectations last week. According to Bespoke Investment Group the S&P 500 on Thursday “had dropped nearly 4% from its pre-market highs before staging an epic rally of 5%.” They point out that this has only happened nine times since 1983. Now investors and traders are wondering what this reversal might mean for the rest of the year.

I remember the last occurrence well as it is often part of my teaching on the merits of advance/decline line analysis. It ended one of the sharpest corrections early in the bull market as recession fears then were also rising. So how does the current technical outlook compare with October 2011?

The reversal occurred on Tuesday, October 4, 2011, as the stock market had peaked in July ahead of the downgrade of U.S. Debt on August 5, 2011, which accelerated the selling. The market had dropped on the 1st day of the new quarter and then gapped lower on October 4th. SPY made a new yearly low in early trading that was met with buying. After a SPY low of $107.43, it closed at $112.34.

It was a positive sign that while the SPY was forming lower lows, line a, the S&P 500 advance/decline line had formed higher lows, line c. This positive or bullish divergence was a sign that the buyers were taking over.

MORE FOR YOU

In 2011 the confirmation came seven days later when the A/D line overcame the resistance at line b, on October 12th. My contribution to Forbes the following day was “Be Bold, Be Fearless…Buy the Dip”. For the last quarter of 2011, SPY was up 11.6%.

After such a horrible stock market performance so far this year, could we see a similar year-end rally as we did in 2011?

The sharp selling last Friday after Thursday’s reversal caused some to stay bearish. Of course, one day does not make a trend so I wanted to see if the selling continued Monday before completing my analysis. The massive rally on Monday erased Friday’s losses as the S&P 500 was up 2.65% with 90% of its stocks advancing. The Nasdaq 100 added 3.5%.

The Spyder Trust (SPY) through Monday’s close does not look as strong as it did in October 2011. To understand what is needed to confirm a bottom we can just review what happened in June and July.

On June 17th SPY formed a doji (see arrow) after dropping below the daily starc- bands which was a sign that SPY was very extended on the downside. Over the next three weeks, there were rallies and then declines as the 20-day EMA started to flatten and the S&P 500 Advance/Decline line developed a range.

On July 20th, line d, the A/D broke out of its range as its WMA was already rising. A few days later the A/D line resistance from late March high, line b, was also overcome. The rally progressed nicely as it peaked on August 16th as rates had again started to turn higher. That week’s lower closer indicated the rally could be over as stocks were one of the four markets that I thought traders should watch.

By the end of August, the A/D line was in a well-defined downtrend and below its declining WMA. The WMA was briefly overcome in September but it did not stop declining. Even after Monday’s sharp rally, the A/D line is still below its declining WMA. A move above the downtrend, line c, is needed to signal a major change in the stock market trend.

Stocks have added to the gains early Tuesday with the SPY up another 1% as all sectors are higher by mid-day. My technical evidence suggests it is too early to be confident that a market bottom has been completed. I do think that the odds favor higher stock prices heading into the end of the year and the confirming technical signals are likely in the next few weeks.

Though the immediate impact is mixed according to Bespoke, the average one-year gain “was 14.6% and positive returns eight out of nine times.”

Typically, there are signs ahead of a market bottom that identifies which stocks and ETFs will be the leaders once the market starts to trend higher. The evidence regarding the new leaders is already building which will be the focus of my next series of articles.

Comments are closed.