WASHINGTON, February 5, 2018: Are we witnessing a surprise stock market crash in progress? Immediately after Monday’s 9:30 a.m. opening bell at the New York Stock Exchange, the stock market resumed Friday’s catastrophic 2+ percent Dow decline. Having already lost more than 600 points at Friday’s closing bell, the Dow again plummeted this morning by more than 350.
Not long what looked like Phase II of a continuing crash, the Dow and other major averages made a dramatic comeback, surging back toward Monday’s breakeven point. But, after teetering painfully close to the zero line, all three major averages – the Dow, the S&P 500 and the NASDAQ – resumed their declines once again.
As we began to write this column – approximately 11:30 a.m. ET – the Dow was down again some 124.97 points. The S&P 500 was 11.40 to the negative, and the NASDAQ was off by 13.71 points. Only the NASDAQ is close to breakeven today, off just 0.20 percent, largely due to a nice comeback in the shares of a badly battered Apple (symbol: AAPL), which is a major contributor to that average as well as to the Dow Jones 30 industrials.
This continuing uncertainty could end well today. But it also might encourage another selling panic like Friday’s, causing yet another crash before this game is played out.
The bad news today is the continuing massive decline in market averages. The good news is the fact that stocks are violently whipsawing today, ranging from considerably down to almost up. Action like this indicates that we’re probably on the verge of at least a nice short-term rally, as indicated by our $NYMO chart above. But the uncertainty could also encourage another selling panic like Friday’s, causing yet another crash before this game is played out.
The $NYMO chart illustrates the current and historical movement of the McClellan Oscillator, which for us has proved an uncannily good predictor of general stock market moves. Wikipedia provides a nice, general definition for this key technical indicator:
“The McClellan [O]scillator is a market breadth indicator used in technical analysis by financial analysts of the New York Stock Exchange to evaluate the balance between the advancing and declining stocks. The McClellan oscillator is based on the Advance-Decline Data and it could be applied to stock market exchanges, indexes, portfolio of stocks or any basket of stocks.”
The McClellan Oscillator tends to work because it’s based not on the number of points stocks in the NYSE average – generally America’s largest companies – advance or decline. It’s based instead on that number plus the volume of trading on a given day, i.e., the total number of shares traded.
I’ve noticed anecdotally for years that a big jump or decline in the averages on a given day tends to be fairly insignificant, if not irrelevant, if that large move in the averages occurs with little trading volume to support it. Such days might include trading days directly before major holidays (like Tuesdays and Wednesdays before Thanksgiving weekend) and often during August, the last month when American families generally can take advantage of summer vacation season.
Whatever the market’s condition, when trading volume is low, the current trend is somewhat suspect. On the other hand, when trading volume is high, significant moves up or down need to be paid special heed. That’s precisely what the McClellan Oscillator is such a blessing to investors like me who trade and invest on their home computers. The Oscillator essentially lets you know whether a current move is important, or whether it’s like a head-fake.
When the Oscillator heads sharply above or sharply down from its zero-line (neutral), it indicates the market is hitting overbought (too much optimism) or oversold (too much pessimism) extremes.
When a big up-move or down-move peaks, stocks and averages tend to violently react by heading very rapidly in the opposite direction. This generally violent reaction is one way to “correct” overbought or oversold extremes, and such reactions are almost inevitable when the McClellan Oscillator hits either extreme. The downside reaction can be particularly brutal, leading to high bearishness resulting in a market crash.
In the chart above, which displays the oscillator action as of last Friday’s market close, we can see that while stocks were strongly bullish dating from roughly mid-December 2017, and while they were significantly above the zero line, they were only modestly overbought according to this indicator.
In fact, the last time stocks entered “extremely oversold” territory was right at the beginning of September, when the oscillator pinned in the +125 area. Note that after some choppy fluctuation, the market began a steadily and sharp decline before bottoming in mid-November in fairly heavy oversold territory. At which point, stocks began their snapback comeback, sharp at first, more measured after that.
Dave Fry, formerly chief guru for the excellent but now-closed “ETF Digest” online investment advisory service, always regarded +60 or -60 on the oscillator as the beginning point for extreme overbought or extreme oversold conditions.
By that measure, the November 2017-January 2018 bullish situation was bouncing regularly into overbought territory throughout that November 2017-January 2018 timeframe without actually correcting until mid-January 2018.
Even then, that correction was something of a head-fake, as it led to another week’s worth of “buy the dip” bullishness. That’s what likely led to this past week’s savage bear raid. As of Friday’s close, markets had hit their worst downdraft over the most recent 365 day period, during which the previous oversold bottom occurred during the nasty August 2016 correction.
It was at that point that the McClellan Oscillator bottomed out at around – 250 give or take, a nasty crash climax that almost immediately triggered the sharpest rally of this time period.
With the oscillator having bottomed last Friday at -271.65, we are likely on the verge of another YUGE rally to the upside. Today’s wildly gyrating price action may be an indication that this rally is near, though at the moment I’m writing this sentence – about 12:15 p.m. Monday – the Dow has slumped again, down -223.75 points and closing in on another 1 percent decline.
UPDATE: As of 1:30 p.m. ET, the Dow is down 450 points, closing in on a nearly 2 percent loss on the day.
That said, a little bit of “dip” buying has been sneaking in here, an indication of more to come. I just don’t know when. We could endure another crash today until all the weak stock holders are flushed out in the ensuing panic.
On the flip side, a McClellan Oscillator snapback rally doesn’t necessarily mean an immediate return of a stampeding herd of bulls. The latest sharp drop in the market has almost certainly scared even the most optimistic investors. Even so, the current situation should gradually resolve to the upside, though not without some further moments of investor terror.
We got caught in the current downdraft in a pretty fully invested situation, so we’re not in a mood to dump our stocks, save for one or two that have clearly found themselves in trouble. On the other hand, we’re not eager to buy stocks either right now, as there’s still significant potential for further nasty drops after the snapback rally begins.
This is not a comfortable situation, and it’s exacerbated this week by a return in Washington of the recent DACA-budget asininity. Act II is set to play out at 12:01 a.m. Friday when the government’s latest temporary spending authority runs out, which it likely will as it’s being held hostage by the Democrats’ intransigence on the matter of unlimited immigration that’s key to its continuing dominance over national politics.
With nonsense like this continuing to dominate the economic headlines, it’s tough to see how the imminent snapback rally in stocks will gain much staying power, even though the McClellan Oscillator is clearly predicting it.
It’s a mess, and it’s very confusing. But I’ll keep you posted this week on my own current state of befuddlement. It would be nice, however, if voters on both coasts would start sending reasonable people to Congress rather than ideologues. Markets love certainty. But that’s in short supply right now, so investors will continue to travel at their own considerable risk this year.