Stock Indexes Follow-Through On Day Six Of Rally Attempt; Something Seems Wrong About This Follow-Through

March 22, 2007

Stocks were boring and dead all day long, until 2:15pm when the Fed announced their decision on interest rates. When that happened, stocks exploded to the upside, destroying shorts in the process. The party was not started based on the decision, as everyone expected rates to stay at 5.25%. The fireworks erupted because the Fed left out the hawkish comments and adopted a more neutral rate policy. That sparked non-stop buying on strong volume, into the close.

At the close, the Nasdaq led the way with a 2% rally, retaking its 50 day moving average. The SP 500 and NYSE also retook their 50 day moving averages, with each rallying 1.7%. The SP 600 gained 1.6%, the SP 400 rallied 1.4%, and the DJIA gained 1.3%, rounding out a strong day in the markets. The two indexes that are throwing up a red flag to me are: The IBD 100 and the IBD 85-85 index. The IBD 100 gained 1.8% and the IBD 85-85 gained 1.6%, both lagging the Nasdaq’s gains. Normally at the start of a strong bull market, where we get a follow-through, these indexes will lead the market. They did in all the other bottoms, since October 2002, except the most recent one in July/August. Then these indexes also lagged in what turned out to be the weakest bull market I have been a part of.

Volume was much higher today on the NYSE and the Nasdaq. Nasdaq’s volume came in higher by 26%, but the NYSE only saw a 12% jump in volume. That is not a big volume increase over the previous day on such strong price gains. The other problem with the volume is the fact that on the NYSE it was only even with the 50 day volume average. On the Nasdaq it was only a tad higher than the 50 day volume average. On the best and most powerful follow-throughs that launch strong rallies, the indexes will normally launch a rally on volume well above this average. That did not happen this time, so this is another red flag on the rally.

Underneath the rally was quite broad and had strong leadership. Advancers beat decliners by a 9-to-2 margin on the NYSE and by an 11-to-4 margin on the Nasdaq. There were 373 new highs to 57 new lows, showing that there are plenty of stocks moving into new high ground while the indexes still hang below their highs. The only bad thing is that most of these new highs are in defensive stocks and old leaders. The oil & gas stocks are all over this list, just like they have been throughout the past four years. Obviously, there is nothing new and exciting here.

But even with the old leadership from the Oil, Steel, and Metals stocks, there was a pocket of strength in the technology sector. The electronic-semiconductor equipment sector rose 2.8%, the computer-data storage rose 3.1%, and the computer software-desktop group gained 3.3%. They are down there on the industry list, compared to these old leaders, but it is still a good sign to see some tech stocks show up with the old groups. This shows that there could be a rotation into a new fresh area of the stock market.

Let’s get back to the actual market. This market, as of right now, is in a confirmed rally off of a follow-through on the sixth day of the rally. However, as you have just read, there are some problems with the actual follow-through. But the biggest problem is with the actual stocks in the market. Where are the pretty longs? They are not here! Many stocks are still very ugly after the nasty February sell-off and even if they have recovered have done so on very low volume and with very V-ish patterns. Besides that the BOP on these recovered stocks are not in the green area. Most charts are colored yellow and red; not green, like my best performing stocks ALWAYS are. The few stocks that are green are very extended and are no way in a safe position to go long. Unless you are already long, you just have to be patient for better setups. The majority of stocks are extended, ugly, or too red to be worth my time.

If this is a real rally, however, we will see some stocks start to form right side of bases on green BOP and heavy accumulation. If we see that happening within the next two weeks to a month, then you know this rally is for real. However, if we don’t see stocks start forming some beautiful green patterns with tight price action and accumulation, you can forget about this rally holding and/or producing any kind of gains we can make a living off of.

Speaking of this rally, let’s get back to it. If this rally does not continue to make gains on heavier volume and we do get a distribution day in here, along with stocks not showing up with pretty charts, you can be sure this rally will not hold. If that is the case, it could get ugly. But we probably have a while to go before that happens. The put/call ratio is still near 1, at .94. Traders are still betting against this rally. That is bullish in the short-term, but it is no guarantee for the long-term.

This correction was simply too short, also. The fact that we already have a follow-through only a month after a nasty sell-off does not give us time to have stocks create beautiful sound bases. Without the proper time, you get a lot of ugly V shaped bases and not nice round green bases. These V shaped bases are always more prone to failure. You can go back throughout history and do a study on follow-through days that come less than two months from a top. You will find that they, along with the V shaped stocks, fail quite often.

The best follow-throughs, as IBD said today, come at least four to five months AFTER a top. The ones before the four to five months normally fail. A market that has a follow-through after four to five months usually has a TON of stocks that are breaking out of nice long green bases. And if they don’t show up immediately after the follow-through, the odds are high that many leaders will breakout within the next few weeks, as the proper time has been put in to create nice long bases.

Remember, not all follow-through days work. However, no bull market has EVER started without one. They just don’t normal start big powerful bull markets this soon after a sell-off begins. So don’t be surprised if this one fails also. I know one thing: Unless I start getting more green round charts in stocks with great EPS and sales growth, I will not be expecting to make much money in this market enviro. Have you seen the VIX? The stupid thing is back down to the 12 area. Just a few more days of gains and it will be sub 10 again. That will guarantee us very few longs that will make 100% or more gains. You simply can not make big money with the VIX down here. We need a higher VIX, to make big money. The only way to have that is for us to have a big sell-off. Something we have not had since 2002.

I have an MRI scheduled tomorrow due to numbness in my L1 to L5 region. So I might not be around as much as I normally am. For that I apologize. Aloha and I will see you tomorrow in the chat room. Have a great Thursday!

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