Stuck in the Mud

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Since the Federal Reserve announcement of a third round of quantitative easing, the market has been stuck in the mud. The S&P 500 closed at 1460 on Fed day -- Thursday, Sept. 13 -- and, one week later, it's still at that level. Have the bulls won because the market didn't go down, or have the bears won because it didn't go up? I say it tells us not much has changed.

The stocks that sank the most during the spring decline gave the most back in this recent overbought situation -- think Financial Select Sector SPDR XLF , Market Vectors Oil Services OIH and the Dow Jones Transportation Average. Meanwhile, the stocks that have performed well all year continued to go on their merry way, such as Apple AAPL , homebuilders and biotech. So QE Forever might have produced a surge on the day it was announced, but ultimately the market went right back to doing what it had been doing.

For example, the dollar-euro currency pair is right back where it was at the market close on the day of the Fed announcement, and bond yields are as well.

As we approach the new quarter later this week and early the following week, we will finally have worked off the overbought reading and move back to a short term oversold condition. In fact, if we weren't approaching the end of the current quarter, I'd look for the market to continue struggling on the upside.

Away from that, I once again want to review the concept of a retest. In a market decline, stocks will reach a point that finds it grossly oversold, and in these cases the Oscillator makes a lower low. Typically we find, at some point in that same time frame, the number of stocks making new lows expands to a very large number. Usually there are other extremes, as well, but the point is that the market reaches some sort of a momentum extreme.

It is at this point that I typically explain the market requires a rally, followed by a retest, in a W-shaped pattern. On the retest, if we see fewer stocks at new lows and/or a higher low in the Oscillator, then we have seen a successful test of the lows. If for some reason new lows expand or we see a lower low in the Oscillator or other indicators, we know the test was not successful and that the trend remains downward.

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Overbought/Oversold Oscillator -- NYSE

Overbought/Oversold Oscillator -- NYSE

The upside is no different. On Sept. 14, the Oscillator reached a higher high and the number of stocks making new highs surged to just shy of 500 stocks. Even volume expanded. At some point those indicators need to be tested. With lows in the market, a successful test would reveal that the selling has been done and is drying up. With highs in the market, the testing is to see if there is still some buying left, or if it has it been exhausted.

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Number of Stocks Making New Highs -- NYSE

Number of Stocks Making New Highs -- NYSE

My Oscillator is due to become moderately oversold Tuesday, but stands to reach a better oversold condition as we enter October. So it's in early October that I expect the next true test of the upside. Oh, sure, stocks might rally this coming week because of the end of the quarter -- but it's the first week of the month when I believe we'll see the rally that gives us the real test of what sort of buying power is still in the market.

HR

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Overbought/Oversold Oscillator -- Nasdaq

Overbought/Oversold Oscillator -- Nasdaq

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