The 'churning' that has been seen in the S&P and Dow over the last week may be about to end. There have been three new signals in other indices, two of which are bottom extensions in the Pharma and Media sectors. We pointed out (most recently in the September 28th edition) that the sector 'rotation' of the last few months has led to top extensions in some areas but bottom extensions in others. On that occasion there was a bottom signal in the beverage sector which led to a general rise in stocks across many sectors in the subsequent few days until more top extensions signalled the end of that move about a week later.
This time the bottom extensions are in Pharma and Media, while Chemicals, Semiconductors and a few other sectors have been hitting new highs and making top extensions:
Yet more sectors have been trading sideways and making compression signals. All this means that the 'rotation' is likely to continue as sectors come and go in the market's esteem. More importantly, the new compression in the Value Line index in the first row of charts above shows that there is a new general move coming. As ever when compressions occur, we cannot tell whether they will start an upmove or a drop - they signify a knife-edge that can mark a new move either way. Instead we prefer to wait and see, moving to the sidelines until this compression resolves.
As a general note on mature stock markets - a bubble can only form when an existing bull market gets out of control. Conditions exist for that to happen here, as the background sentiment remains quite bearish and there is a general expectation that prices will fall as interest rates continue to rise. Bear market never start with a bearish consensus, but only when there is a general feeling of resignation that prices may have to rise yet further before the end is reached. Are we there yet?
Historically, bull markets that turn into bubbles usually produce top extensions at weekly and monthly scales some periods before the eventual top is reached. This has been happening already in the Dow's recent rise, shown here next to the Nasdaq bubble-and-bust of 2000:
So, in the later stages of a bull market that has the potential to transform into a bubble it is unwise to rely on longer-term top extensions to 'pick the high' as they merely warn that a high point is coming. Shorter-term top extensions will usually identify the timing of market dips along the way but bigger reversals will often start with compression signals that are generated after a period of trendless trading. The end of a long bull market will usually require a weekly-scale compression to bring it to an end, but it is just possible that a daily-scale version could suffice.
In the meantime, this new daily-scale compression in the Value Line may well break upwards, so leading to yet more new index highs across the board - for now we wait and see which way the next move will be and then we will follow it.
All signals courtesy of software supplied by our friends at Parallax Financial Research www.pfr.com