Market Minute: August 24, 2010: Underlying support fades

Donald W. Dony, FCSI, MFTA          
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Following the August 18 Market Minute titled “S&P participation remains weak”, underlying support for the S&P 500 has deteriorated during the last few days. On August 18, the percentage number of advancing stocks within the broad-based index had fallen to 50%. In contrast, at the peak of the bull advance in April, that percentage number was over 75%.

Market conditions have continued to change to the negative side. Currently, only 34% of the stocks in the index are trading over their 200-day moving average. This means that 66% are trending down (Chart 1). When the majority of an index’s securities are declining, a downward trend develops. Similar conditions occurred in late 2007 and throughout 2008.

Bottom line: Market support has shifted faster than expected to the negative side. Advancing markets require a clear majority (60%-90%) of their underlying stocks to move higher if an index is going to trend up. When the percentage falls below 50%, markets start to decline.

Investment approach: Models indicate that most indexes trade on an approximate 4-month cycle. As the last trough was in late May to early June, the next probable low can be anticipated in late September to mid-October. With the underlying support for both the S&P 500 and TSX quickly eroding, increasing downward pressure can be expected over the next 4-6 weeks.

Investors may wish to take a very defensive stance this month by increasing cash percentages and raising stops. Good value opportunities are anticipated after this correction in Q4.

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