I’ve been suggesting that the markets were setting up for a potential winter rally by trading in a short-termed consolidation pattern for over a month now. The support line for this consolidation pattern at 1120 for the S&P 500 was broken yesterday, and markets continue to fall today. In situations like this, one of the only ways to spot a potential capitulation bottom is when we get a combination of oversold momentum and oversold sentiment readings. I tend to combine daily 14-period RSI with the ISEE call/put ratio. The ISEE index touched the oversold level I like to see on Monday (around 80), but the RSI momentum indicator is not yet below 30. Thus, we are in oversold sentiment territory, but momentum isn’t reaching my oversold criteria for a reversal day. Given today’s earlier sharp movements, we may get that reading any day now. Rydex mutual fund readings (another sentiment indicator) has also moved to a 157% cash/equity ratio. This means that their clients hold $1.57 of cash vs. $1.00 equity as of yesterday–historically anything over 150% cash/equity has been bullish for markets going forward (10 out of 10 times its happened since 1997, markets were higher 1 month later according to sentimentrader.).
Meanwhile, the breach of 1120 by the S&P implies a potential 1050 downside target, which I have mentioned a few times in this blog site. Whether that level is reached or not will depend on the follow-through from yesterday’s drop. If we see a quick rebound, then the breach of 1120 would be known as a “spike”. I am writing this at the halfway point on Tuesday – and I don’t see a ton of follow-through conviction by the bulls just yet. We shall see.
Seasonality studies by Don Vialoux and Brook Thackray show various potential entry points for the month of October, including around the 10th. I mentioned in a prior blog that this date coincides nicely with a 107 day cycle that is followed by respected Canadian Technical Analyst Ron Meisels. Add in the upcoming earnings season, and we still have a reason to see some upside after October.
I’ve been holding cash in the equity model I manage for clients – although it’s never enough (unless you are 100% cash!) during a downturn. When I deploy the remaining cash is yet to be determined. It is my opinion that we will have a better picture of whether the market can put in its bottom and prepare for a seasonal rally by the end of next week. I’ll post again next Monday, or earlier if new developments occur.