Is The Correction Over?

It could be but first off we should explain that purists would not call it a correction since the Dow and S&P 500 did not fall in excess of 10%.  The S&P 500 fell 5.76% on a closing basis between January 15  and February 3, encompassing 12 trading sessions.  In the process the overall market worked its way into a heavily oversold condition with our OB/OS indicator registering a -4.00 on Monday, February 3 which has turned out to be the absolute lows of the sell-off thus far. This indicator is a 19-day exponential moving average of the Value Line Geometric Index.  Whenever the index falls 3% or more under the 19-day average, we consider the market to be heavily oversold.  The initial rally off of the heavily oversold condition  was impressive with the S&P gaining 4.5% in six trading sessions.     In the process, the oversold condition was worked off with the OB/OS indicator registering a +0.38 on Tuesday, February 11.

It’s interesting to note that the OB/OS indicator also pinpointed the lows right to the day of last year’s May/June sell-off when it fell to -3.13 on June 24.    Going back still further, the OB/OS indicator for all intents and purposes pinpointed the lows of the September/November 2012 sell-off when it dropped to -3.62 on November 14.  The bottom came the following day with the S&P 500 losing two points.  One indication that the lows of the sell-off might be in was the recent spike in the VIX followed by a sharp drop below its 200-day moving average.    The VIX peaked at 21.44 on February 3 and pulled back below its 200-day line six sessions later.  There was a similar peak four months ago when the VIX hit 20.34 on October 8 followed by a pullback below the 200-day line seven sessions later.  At last year’s June lows, there was  a similar spike up to 20.49 and a return to the 200-day line 10 days later.

One of our favorite indicators is the NYSE daily Advance/Decline Line.  As you can see by the chart, the A/D line has broken through its mid-January high with authority.  Historically, this bodes well for the market because the A/D line usually tops out well ahead of the key averages.  Its ability to post new highs is indicative of a healthy bull market that has further to run.

Check out the chart of bullish/bearish sentiment maintained by Investors Intelligence.  There was no question that investors’ expectations were sky high prior to the recent sell-off.  By December 31, advisory bulls had reached a multi-year high of 61.6%.   This was excessive optimism to an extreme. The market which invariably does what it must do to fool the majority headed south.  Since then, there has been a major turn in sentiment with the percentage of bulls dropping all the way down to 41.8%, the lowest level in some 23 weeks.  To quote directly from Investors Intelligence, “Bullish readings above 60% signal high risk.  Now those conditions have been relieved with a reading slightly below the 45% level that is typical in a rising market.  The lack of current optimism has to be considered positive for stocks, with the suggestion of lots of new money now on the sidelines.”  The weekly survey by the American Association of Individual Investors, AAII, has also taken a dramatic turn.  As of February 6, the bullish contingent was all the way down to 27.9% which marked the lowest level since April 18 of last year.  That was not a good time to be bearish.  The S&P 500 surged 8% over the next month.   The AAII bearish continent is now up to 36.4% which is the highest level since late August.

As this is written, the benchmark S&P 500, NASDAQ Composite, Russell 2000 and S&P MidCap Index have all moved back above their 50-day lines.  The S&P is exactly 1% below its January 15 all-time highs while the NASDAQ which has led this rally is within a hair’s breadth of a multi-year high.  The Russell 2000 which has been in the forefront of the bull market is lagging but has managed to move back above its 50-day line.  The Dow is also lagging and is still below its 50-day line.  It should be noted that most of the key indexes penetrated their December lows during the sell-off.  This created a great deal of technical damage and certainly placed the burden of proof on the shoulders of the bulls.  What we would like to see is a clear cut breakout by these key indexes (similar to the Advance/Decline line) through their January highs.  Our short term model still hasn’t rendered an all clear, however, our long term model is still highly bullish.  Bottom line, it’s a bull market; stay fully invested.