Last month we discussed how we look for positive divergences in a declining market. As you'll see in this article, we have in fact seen some positive divergences--where a stock or index and a relevant indicator are moving in opposite directions.
Fewer new lows
Let's take a look at stocks making new 52-week lows (shown in the following chart). At the lows in October, there were almost 3,000 new lows on the NYSE. At the November lows in the market, there were just under 2,000 new lows, giving us a positive divergence versus the October lows. At the most recent low in the S&P 500, the number of stocks making new lows did not even reach 1,000. The peak reading on this lower low in the S&P 500 Index was "only" 827 stocks. The reason we pay attention to such positive divergences is that we want to see if individual stocks are underperforming or outperforming the popular stock indexes such as the S&P 500. If the stocks are diverging or not performing in line with the S&P, then we have a divergence. If the S&P makes a higher high and the number of stocks making new highs lags the previous reading, we have a negative divergence. In a declining market, we look for positive divergences in spotting fewer new lows. Source: Helene Meisler, as of March 13, 2009.
Getting oversold in the intermediate term
In addition to the positive divergences we found at the lows in early March, the market appears to be getting fairly oversold on an intermediate-term basis. I say "getting" fairly oversold because I believe there could be more trips to the downside in the next few weeks before the market may reach a maximum oversold reading on an intermediate-term basis. This is a momentum indicator. Just being oversold is not a reason to rally--however, when a market is oversold, it tends to lose its downside momentum. In my experience, this usually means that any piece of good news can rally the market. For the intermediate-term oscillator, I use the 30-day moving average of the advance-decline line. In the following chart, you can see that it is at a higher low than the October and November lows--another positive divergence. However, the math says the oscillator may fall further in the next two weeks. I do not expect it will break the lows of last autumn, though I believe any positive divergence may now stay in place. Source: Helene Meisler, as of March 13, 2009.
Bearish sentiment signals a turn
Finally, I want to draw your attention to sentiment. The American Association of Individual Investors (AAII) conducts a weekly survey on their website. Two weeks ago, the percentage of folks who were bearish on the market reached an all-time high of 70%. Source: Helene Meisler, as of March 13, 2009. AAII has been collecting this data since the mid-1980s, and even the stock market crash of 1987 did not have the percentage of folks who are bearish to be that high. Neither did the bear market of 2000-02. Such extreme readings have often come prior to a turn in the market, so this is considered a contrary indicator where I would want to be on the other side of the consensus. Therefore, I believe we may have an intermediate-term rally on our hands. However, another move down in the next few weeks would not surprise me at all. I would expect such a rally to be in fits and starts and, at this point, I believe it may last until sometime in mid- to late April. Whether it has staying power beyond that is still to be determined.