It’s been a touchy week for stocks: From Monday’s high, the Dow Jones Industrial Average has lost about -4%. So was that it? Just another dead-cat bounce within a downtrend measured from April’s highs? Or is this just a temporary pullback within a new uptrend? So far, the evidence suggests the more optimistic scenario is playing out. And that makes the current dip a fantastic buying opportunity.
Technically, I continue to see signs of a market finding its footing after a bad fall earlier this week:
- Breadth improved on Wednesday over Tuesday’s decline, with net advancing issues increasing 89% on the NYSE despite a fall in prices. The measure of up volume to down volume also improved, with down volume only accounting for 56% of total volume versus 93% on Tuesday. This means that the intensity of selling is beginning to fade.
- The NYSE Arms Index, which is the ratio of advancing issues to decliners divided by up volume over down volume, closed at 3.5 Tuesday. I’ve noticed that any Arms reading over 2.5 represents a short-term bottom that stocks trend to climb out of.
- The euro-to-dollar cross rate– a proxy for risk appetite — has gained more than 1.8% over the last two days as euro strengthened and the dollar weakened. Stocks and commodities tend to do well when this cross rate rises.
- The CBOE Equity Option Put-to-Call Ratio jumped to fresh highs — exceeding the levels reached during the May selloff and returning to heights not seen since the credit meltdown of 2008. This measure is calculated based on the volume of equity put trading vs. call trading. When it’s high, as it is now, it’s a contrarian sign that too many options traders have piled into put options to bet that stocks are going down. So naturally, prices are probably going to go up.
- Given Wednesday’s bad home sales report, you’d expect homebuilding stocks to get clobbered on the expectation that earnings growth is set to slow again. But after falling more than 2.1%, the Homebuilders SPDR (XHB) turned tail to finish the day with a 1.2%. The XHB is down 23% from its April high and is one of the least-loved and most-shorted segments of the market. Today’s action suggests people used the terrible sales numbers to cover their shorts — which represents the first step of the shift from downtrend to uptrend.
Overall, for all the reasons above, and with the Russell 2000 forming what appears to mini head-and-shoulders reversal pattern, I continue to believe that a move higher is imminent. The easiest way to get exposure is with the iShares Russell 2000 ETF
(IWM).
