Pullback Is Likely, But Not Guaranteed
by Carl Swenlin
April 17, 2009

The bear market rally has continued to move prices higher, and the strength is greatest in the smaller-cap stocks. For example, the S&P 500 has rallied 30% from the March lows, but the Rydex S&P Equal Weight ETF (RSP) has advanced 45%. Looking through the list of the Spider Sectors and their equal weighted counterparts, we can see that the equal weighted indexes are doing much better than the traditional cap-weighted indexes. Nevertheless, the S&P 500 has managed to move above the medium-term resistance presented by the declining tops line of the recent trading channel.

As we have noted in recent articles, prices have been advancing in the face of overbought short-term indicators. See the CVI below. It has stayed mostly on the overbought side of the zero line, and prices have moved higher as th CVI has diverged negatively. This is bullish and is evidence that the rally is probably not over; however, medium-term indicators are now becoming overbought. Note that the S&P 500 PMO (above) is above 2.5, and the VTO below are very overbought.

On the chart below we can see that our intermediate-term breadth and volume indicators are very overbought by historical standards. In a bear market this can be a problem; however, a bear market rally is like a mini-bull market, so it is possible for overbought conditions to clear without much (or even any) price deterioration.

Bottom Line: Based upon my perception of market behavior versus indicator status, I am expecting some kind of correction, possibly a short consolidation -- a week or so -- or a quick, scary couple of down days. Regardless of how the overbought conditions are cleared, I am assuming that the rally is not over and will persist for at least a few more weeks.

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MAIL

Carl: Do divergences in the oscillators such as the OBV set or the ITBM(V) set have importance? Or are divergences in the PMO the only divergence that matter?

ANSWER: A bullish divergence is when the price index makes a lower bottom at the same time an indicator makes a higher bottom. A bearish divergence is when the price index makes a higher top at the same time an indicator makes a lower top.

In general, a divergence on any indicator qualifies for attention. More important to remember is that bearish divergences are less reliable predictors in a bull market, and bullish divergences are less reliable in a bear market.

Carl

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MECHANICAL MODELS

We rely on our mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have included the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

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Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your tactics and strategy if conditions change.

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BIO: Carl Swenlin is a self-taught technical analyst, who has been involved in market analysis since 1981. A pioneer in the creation of online technical resources, he is president and founder of DecisionPoint.com, a premier technical analysis website specializing in stock market indicators, charting, and focused research reports. Mr. Swenlin is a Member of the Market Technicians Association.