As can be seen in the 3D histogram below, the statistics for the weekly timeframe are slowly exhausting the number of stocks under accumulation stages. While a majority of stocks still remain in a confirmed weekly strong-to-medium mark-up stage, the progressive shift toward distribution is normal and unavoidable. For the whole market, the shift from weakening mark-up to distribution stage could last between two and four more months at the current pace of rotation. However any negative catalysts (end of QE, geopolitics, etc.) could precipitate the rhythm of the topping process easily, as the weakening uptrend would be fueled mostly by bouncing stocks instead of stocks breaking out of sound accumulation bases. It increasingly feels like we’ll have another repeat of the classic “Sell in May and go away” phenomenon.
The weekly stages score finally broke below its uptrend support line and is suggesting becoming more defensive for the intermediate term timeframe. We’re reaching the point where probably most of the leading stocks will start trapping late buyers as early institutional buyers from last September will increasingly intensify their distribution programs into any further bouts of strength. The maximum score attainable would be a 10 if all stocks were in strong mark-up sub-stage at the same time. This is obviously impossible and a realistic target is probably around half that ideal score. The peak above 5 one week ago may very well have marked the top of the current weekly uptrend and any new highs will become increasingly unsustainable.
On the daily timeframe, the leading percentage of stocks in strong mark-up sub-stage was cut by one-third to 21% last week in spite of Friday’s strong bounce. Stocks under early and mid-distribution are now totaling 32% and the percentage of stocks under strong decline was almost doubled to 11%.
The daily stages score graph reflects well the slow and growing deterioration of the daily market structure with constant lower lows and lower highs since mid-October. It even briefly undercut the November lows last Wednesday and Thursday. Another wave of selling in the near future could quickly push the daily score in negative territory under the zero line. The current weekly market structure discussed above suggests a higher daily scoring high will be hard to achieve due to lack of stocks in sound weekly accumulation stages.
Investor’s Business Daily (IBD) changed its market outlook back to “Market under pressure” last week based on the number of leading stocks being heavily sold and the additional number of distribution days in a very short period of time. Judging by the weekly closes of IBD’s proprietary volume-based Accumulation/Distribution ratings percentages, there is no doubt that institutional players are distributing leading stocks as the percentage of A rating (leading stocks) was almost cut in half last week. So far, they don’t seem to be aggressive sellers of lagging stocks but this could be the next logical step in a topping process.
Most major tops are triggered by a sudden drop in liquidity. QE2 is programmed to end in June and any Fed plans beyond that date is conjectural and uncertain. The market usually anticipates well in advance such liquidity drains. If you are in the camp of those who believe that QE2 and the Fed will save this market under all circumstances, our friend Bob English from Precision Capital Management issued a serious warning last week which further confirms that large players are reluctant to put their fresh liquidity at risk with current equity valuations.
“Furthering our concern for the intermediate term, however, is the Federal Reserve’s monetary base statistics released after the close, which revealed that over the last two weeks, banks stashed another $122 billion at the Fed to collect interest at 0.25%. Total POMO Treasury purchases over the same period were only $48 billion, and Treasury SFP wind down was $50 billion. Accordingly, there was a net liquidity drain of $24 billion. While there’s nothing to stop these funds from being withdrawn from the Fed banks and deployed elsewhere tomorrow, the escalation of a now six week old trend justifies attention.”
In conclusion, last week marked the first serious confirmation since last September of an ongoing potential topping process. If nothing changes for the better soon, selling leading stocks into strength seems to be the best risk-reward approach from now on and selective short-selling of previous leaders entering a strong decline sub-stage becomes acceptable.