In The Week Ahead: Watch This Chart For Clues Of A Market Bottom

John Kosar's picture

Monday, September 14, 2015 - 12:30pm

by John Kosar

All major U.S. indices finished in positive territory last week, led by the tech-heavy Nasdaq 100, which gained 3.3%. This continued the market's recent pattern of alternating positive and negative weekly closes while digesting the late-August collapse.

This sideways "digestion" is likely to become the springboard for another leg lower within the market's current decline -- its first real correction in years -- or the accumulation phase for its next intermediate-term advance.

Technology and health care led last week as all sectors of the S&P 500 posted gains except for utilities, which lost 0.7%. 

This continued utilities' sharp turnaround. Between July 23 and Aug. 24, the sector outperformed the S&P 500 by roughly 13 percentage points. It then quickly gave back roughly half of those gains, in part triggered by the recent recovery in the yield of the 10-year Treasury note from a test of 2%. 

Yet Another Sign Of An Emerging Market Bottom

In last week's Market Outlook, I pointed out the current extreme in negative investor sentiment. This is a contrary indicator and similar extremes have historically coincided with or led important market bottoms. 

The chart below displays another contrarian sign of an emerging market bottom: the current extreme in negative market breadth.

S&P 500 Chart

The lower panel shows that the percentage of NYSE Composite constituent stocks trading above their 200-day moving average declined below 20% during August. This negative extreme in market breadth has only occurred on four other occasions since 2002, and three of those instances either coincided with or closely led (within two to four months) what arguably were the most important market bottoms during this period.

Watch The Dow For The 'Where' And 'When'

Now that we have determined the market is likely closing in on a meaningful bottom, the more pressing questions are "when" and "where." The best way to answer these is by observing the market's reaction to key underlying support and overhead resistance levels in the major indices, including the Dow Jones Industrial Average. 

DJIA Chart

The chart highlights several well-defined levels above and below the market. The first and most important level is the Dow's 2009 uptrend line at 16,456, which was broken during the late-August market collapse. With trading clustered closely around this trendline over the past several weeks, this marks an inflection point from which the market bellwether will either recover or initiate an even deeper decline.  

A sustained rise back above 16,456 this month would be viewed as evidence that the market recovery I'm expecting may be getting under way now. This would clear the way for at least a retest the Dec. 16 low at 17,068, 4% above Friday's close. An eventual rise back above the 200-day moving average, currently at 17,724, would help to confirm that the larger uptrend has indeed resumed.  

Conversely, if the Dow cannot regain the trendline at 16,456, it would warn of an upcoming retest of the February 2014 low at 15,341, which is 16% below the May highs.

Another Failed Rally Attempt For Gold

About a month ago, I pointed out that commercial hedgers were at a "least hedged" extreme in gold futures. This indicated an aggressive bet by smart money that gold was undervalued. I also said a continuation of the recent expansion of investor assets in SPDR Gold Shares (NYSE: GLD) would indicate there was enough near-term bullish conviction by regular investors to support the rally the commercials were expecting.

The next chart shows a further expansion of assets did occur between Aug. 14 and Aug. 24, which fueled a 5% rise in GLD. But this expansion quickly dried up, taking the air right out of gold's rally. 

These assets actually collapsed back below their 21-day moving average at the end of last week, indicating a new monthly trend of contraction that is characteristic of an even deeper price decline. 

GLD Chart

Therefore, even though the smart money commercial hedgers continue to see value in gold prices, readers should consider moving to the sidelines until investor assets start coming back into the market on a sustained basis.

Start Paying Attention To Copper

While gold prices feel around for a meaningful bottom, copper prices are also on my radar due to current negative extremes in investor sentiment. 

The bottom panel on the next chart shows a survey of individual futures traders' bullishness on copper prices, which is a contrary indicator like the NYSE Composite breadth chart above. It is currently rebounding from an historic negative extreme of just 11% bullish, which has previously coincided with significant bottoms in copper prices.

Copper Chart

Although negative sentiment readings alone aren't enough to signal a buying opportunity, this metric definitely has me watching for more confirming signs of a new buying opportunity in copper-related assets in the weeks ahead.

Putting It All Together

In the past several issues of Market Outlook, I have been discussing a number of market metrics including volatility according to the VIX (Aug. 24), investor sentiment and seasonality (Sept. 8), and market breadth, all of which have historically preceded significant stock market bottoms.

What we don't know yet is whether that bottom is already in place at the late-August lows or remains several weeks or more away. History favors the likelihood that there may still be a bit more work to do on the downside first.  

Meanwhile, I'm closely watching the major indices, including the Dow industrials, for more tangible evidence that an investable bottom is in place.

Looking ahead, I would view an upcoming rise in economically sensitive copper prices as a positive sign of the kind of global expansion that would be necessary to help fuel a sustainable rise in global equity prices into 2016.

News Chart

This article was originally published on ProfitableTrading.com: Watch This Chart for Clues of a Market Bottom.

John Kosar does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.