The last week has witnessed the return of multi-directional volatility in the equity markets for the first time since just before the election in the United States last November. At this point we have little reason to suspect the 2% mini correction in the S&P 500 will turn into a major downside swoon. After all, even though domestic and global politics remain unpredictable, high frequency economic indicators such as unemployment claims, consumer confidence, retail sales, and PMIs remain moderately strong and suggest the 2% real economic growth environment continues (charts 1-4 below). Furthermore, the loosening of financial conditions manifested through a weaker USD, falling rates, and contracting credit spreads should act as a boon to PMIs throughout the remainder of 2017. Even so, we wouldn’t be surprised in the least to see this correction go deeper to wash out some of the excessive optimism in the market. In this post we’ll highlight some of the things we’ll be watching for to help us gauge if market participants have capitulated, which would create an oversold condition to setup the next leg of this bull market.
1) New Lows
Good market lows usually coincide with upwards of 20% of individual stocks making new 65-day lows in price. Currently, only 8% of stocks in our United States index are trading at new 65-day lows, so we’d like to see an expansion of this figure as a sign of investor capitulation.
2) Market Breadth
Markets become prone to sharp reversals higher in price when the vast majority of individual stocks are trading below their own intermediate moving average price level. Readings below 20% or 30% of issues trading above their own 65-day average price are generally consistent with capitulation and oversold conditions. Fully 45% of stocks are trading above their 65-day average price currently, which means that breadth isn’t weak enough yet to signal capitulation.
3) New Highs in Volume
One of the hallmark indicators of investor capitulation is an expansion of individual stocks that are experiencing high trading volume. Selling pressure is usually exhausted when the percent of stocks making new 65-day volume highs expand beyond 20-25%. The current reading is just 2%, so we may need to see considerably more shares trading hands before a good oversold condition develops.