WASHINGTON. As of today’s closing bell, we can confirm it was Comeback Tuesday on Wall Street. Though we can’t exactly guarantee that Comeback Wednesday will follow. But today’s bullish bounce back rally was still a welcome relief. It gave US stocks at least a few hours to try recovering from Monday’s hideous bloodbath. Yesterday, the bulk of US equity issues were metaphorically hanged, drawn and quartered in the worst full-fledged bear attack we’ve seen in quite some time.
But today on Comeback Tuesday, Mr Market recovered a little less than half of Monday’s losses. However, restoring full health to this badly event- and headline-driven market of stocks could end up taking lots more time. I.e., we’re not out of the woods just yet.
That said, today’s nice move back up was fun. And quite a relief, too, at least for those bulls that remain. Whether or not this was only a dead cat bounce, however, remains a tantalizing mystery. But today, we’ll take what we can get.
Let’s go to the charts: The McClellan Oscillator indicates a deeply oversold stock market
Need confirming evidence for what happened and why during today’s Comeback Tuesday? Take a look at our two favorite key charts (hat tip, Stockcharts.com), a team of technical pix that gives us some insight in troubling times like this.
First, here’s the horror show otherwise known as the McClellan Oscillator, as of Monday’s 4 p.m. ET closing bell.
The wavy lines at the right of this chart are all you need to understand just how nasty Monday’s Doomsday Trade scenario really was. It’s the lowest we’ve seen this measure of the market’s trading move this year. And, appropriately, it illustrates a deeply oversold market situation. Confused? Let’s take a look.
An instant McClellan Oscillator primer for those who don’t care about lots of technical details
For those new to this column, and without getting into minute details, the McClellan Oscillator charts the market depth of advancing vs. declining stocks. It quite accurately (in my view) indicates whether stocks are “oversold” or “overbought.” The zero line on the chart equals the neutral point. But nearly always, the chart line closes moderately above or moderately below the zero line on any given day.
If we find the chart closing or spiking considerably above the zero line, that usually signals that markets have become overbought. That means, effectively, that investors are proving rather definitively too bullish on the market. Which, for McClellan Oscillator fans, means that stocks are topping and heading for a downside drubbing, perhaps within just a few days or less.
We experience the same phenomenon if the Oscillator closes or spike considerably BELOW the zero line. That tends to mean that bearish sellers have decided to massacre stocks indiscriminately. It’s a mirror image of the bulls deciding to BUY stocks indiscriminately when the oscillator spikes way above the zero line. When this happens to the downside, it’s highly likely that at least an impressive dead cat bounce is in order to correct the fact that traders and investors have gotten absurdly bearish. Which likely provides a graphic illustration as to why we experienced today’s Comeback Tuesday action.
Monday’s chart is a snapshot of an oversold market situation
Looking at the chart above, we can easily see that last week, the Oscillator began trending down, down, down from the zero line with some force. Downside action accelerated last Friday to the extent that Monday was nearly guaranteed to give the bulls a serious case of heartburn. This was aided and abetted by the increasing US-China trade brouhaha over the weekend. The mood was not helped at all by the twin massacres in El Paso and Dayton. The effects of this tragedy on emotions and on trading psyches were considerably worsened by the media’s balls-to-the-wall flogging of these events to flame out and promote gun control and bogus charges against Trump of alleged “white nationalism.”
All this created a rotten mood among traders Monday. And that wasn’t helpful, because the McClellan Oscillator already warned us Friday that markets teetered on the downside of a slippery slope already. They didn’t need provocations. But they got it with both barrels, if you’ll pardon our metaphor. Monday’s opening bell created a vast and frightening sinkhole from which few stocks escaped. And you can see that quite dramatically in the McClellan Oscillator chart created after the market closed on Friday, August 5.
Enter the spiking VIX, a key tell that spikes when traders freak out
To add to the drama, check out the August 5 COB VIX chart below.
The VIX is a chart that gives you a picture of stock market “volatility.” Which we can roughly translate into “unpredictability,” “wild buying or selling swings,” or, in general, “a very treacherous environment for investors.”
Again looking to the far right of the chart, we can see that the VIX began to spike way up from the zero line (more volatility) last week, with that move accelerating dramatically on Friday. All of which paved the way for Monday’s violent upward spike.
A +16 on this chart indicates that volatility is getting scary. But Monday’s dramatic spike indicated the VIX – and thus the market – were getting way beyond control.
Both charts, viewed in sequence, provide a broad hint that Monday’s violent selloff was overdone
Taken together, the McClellan Oscillator and the VIX presented a frightening picture Monday evening for all but the craziest day traders. Things could have gotten worse Tuesday morning. BUT… when both these charts look too exuberant on the upside, meaning an extreme oversold McClellan Oscillator and a VIX close to flatline; or a time when the Oscillator plunges powerfully to the downside while the VIX spikes above the zero line and closer to the stratosphere… we generally experience an impressive reversal in direction, often within 1-3 trading days. Just like today on Comeback Tuesday.
Based on long experience, plus, persuaded by Friday’s already negative McClellan and VIX charts (see Monday’s initial column), we guessed Monday’s movements in both these charts would end up extremely bearish. So we actually started buying a few issues that already resided in disgustingly oversold territory. When make a move like this during a crash, you wager you can win this somewhat risky bet within a few days. But we’ve learned that the Oscillator is an awfully good indicator of what’s about to happen. So when this chart and the VIX hit absurd extremes, we go contrarian
And voilà! We had a winner this morning, as all three major stock averages spiked way up at the open to relieve oversold conditions. This move has wobbled throughout the day, and there’s no guarantee that we’ll close on the upside. Or that this mini-rally – or dead cat bounce – will continue.
So how about what happens tomorrow?
But today’s at least half-hearted move back into equilibrium is moderately assuring. So we added a little more to our favored positions this morning when things dipped a bit between 10-11 a.m. ET. And as we finish this piece, the market is getting close to its earlier 200+ point spike on the down. And even those recently battered techs are getting some helps from buyers.
At this point, there’s no reason to believe that the bulls have returned with enough force to kick the bears back out of their Wall Street dens. But today’s action does at least offer some hope that the bearishness may not get out of hand after all.
And, better yet, this action helps us justify putting the bulk of our portfolios into less volatile preferred stock issues and broad-based index ETFs. This likely helped us from a far worse battering than we sustained in Monday’s market rout.
— Headline image: A new dawn? Image via Pixabay.com. CC 0.0 license (public domain).