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Here's Why the Market Is Set to Bounce

By Jeff Clark
Tuesday, August 25, 2015

A couple of weeks ago, I told you the stock market was set up to make a big move... but even I didn't expect it to be this big...
The S&P 500 Index dropped as low as 1,970 on Friday. And yesterday, the index opened at 1,900...
Although we're still down only about 10% from the highs reached last month, it feels worse than that. Investors haven't suffered through a correction of more than 10% since November 2011. And I suspect most folks have forgotten what it feels like when their stock market portfolios drop in value.
But as I'll explain below, this isn't a time to panic. It looks like traders will soon get some relief from the pain...
As you can see below, the recent breakdown in the S&P 500 exceeded our target price of 2,000.
This action has pushed most technical indicators into "extreme oversold" territory.
One way to gauge this is by looking at the McClellan Oscillators. These measure overbought and oversold conditions in the stock market. Readings of more than 60 indicate severe overbought conditions, and often precede large declines in the markets. Readings below -60 display extreme oversold conditions, and usually lead to strong bounces in stock prices.
These are the sorts of readings we see at the end of short-term decline phases. And they often mark the beginnings of a stock market bounce.
Let's start by taking a look at the Nasdaq McClellan Oscillator (the "NAMO")...
On Friday, the NAMO closed at -63.
Now take a look at the NYSE McClellan Oscillator (the "NYMO")...
The NYMO closed Friday at -71.
These are among the most oversold readings we've seen over the past year.
Here's how the S&P 500 has performed after previous oversold readings in the past year...
In every case, readings this extreme in the McClellan Oscillators led to solid bounces in the broad stock market. The S&P 500 gained more than 10% in one month when it bounced off of oversold conditions last October.
The most recent bounce from late July, though, was a much more modest 2% gain in about one week.
Given the severity of the decline we've seen over the past week, and the extreme oversold conditions of technical indicators like the NYMO and NAMO, I suspect the coming bounce will be more on par with what we saw last October.
Best regards and good trading,
Jeff Clark

Further Reading:

"Volatility is ready to explode," Jeff wrote last week. His call was spot-on... Yesterday, the "VIX" (the market's fear gauge) soared to its highest level in more than three years. Learn what he looks for right here: Fear Is Coming Back in a BIG Way.
The McClellan Oscillators aren't the only indicators Jeff uses to gauge where the market is headed next... He also uses the moving average convergence divergence (MACD), Bollinger Bands, bullish percent indexes, and the "empty restaurant" indicator.

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Market Watch
Symbol Price
S&P 500 1890.04 -4.1% -5.0%
Oil (USO) 12.55 -5.1% -64.1%
Gold (GLD) 110.31 -0.7% -10.5%
Silver (SLV) 14.13 -3.3% -24.4%
U.S. Dollar 93.60 -2.2% +13.7%
Euro 1.16 +1.8% -12.4%
Volatility (^VIX) 35.70 +27.4% +211.3%
Gold Stocks (^HUI) 121.03 -4.5% -49.2%
10-Year Yield 2.02 -1.7% -15.8%

World ETFs
Symbol Price
Israel (ISL) 18.21 -3.8% +9.8%
India (IFN) 23.63 -5.2% -1.8%
USA (SPY) 191.61 -3.1% -1.9%
Japan (EWJ) 11.56 -3.0% -2.0%
China (FXI) 34.56 -5.5% -14.0%
S. Africa (EZA) 54.50 -1.9% -20.7%
Taiwan (EWT) 12.16 -2.3% -24.0%
Singapore (EWS) 10.19 -3.8% -24.3%
Canada (EWC) 22.98 -2.3% -27.6%
Russia (TRF) 9.43 -2.9% -29.9%
S. Korea (EWY) 45.12 -1.2% -30.6%
Lat.America (ILF) 23.26 -2.7% -41.6%

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Symbol Price
Health Care (IYH) 147.91 -3.2% +12.7%
Biotech (PBE) 51.07 -3.2% +12.1%
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Retail (PMR) 37.24 -0.8% +10.1%
Consumer Svcs (IYC) 135.77 -2.6% +7.9%
Utilities (XLU) 43.87 -2.6% +7.0%
Construction (PKB) 23.60 -1.8% +6.5%
Insurance (IAK) 48.73 -3.3% +3.6%
Defense (PPA) 33.48 -2.3% +3.7%
Financials (IYF) 85.03 -3.3% +2.3%
Big Tech (QQQ) 99.79 -2.6% +1.8%
Real Estate (IYR) 71.66 -3.3% +0.7%
Semis (PSI) 22.83 -0.7% -0.1%
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Alt. Energy (PBW) 4.19 -1.6% -37.0%