What next for Market : 5 Conditions lining up for a melt-up rally ( or possibly bear market reversal ) and October market review

I would like to start off this article entry with the following quote from Charles Dow,

“There is always a disposition in people’s minds to think the existing conditions will be permanent,” Dow wrote, and went on to say: “When the market is down and dull, it is hard to make people believe that this is the prelude to a period of activity and advance. When the prices are up and the country is prosperous, it is always said that while preceding booms have not lasted, there are circumstances connected with this one, which make it unlike its predecessors and give assurance of permanency. The one fact pertaining to all conditions is that they will change.”  – Charles Dow, 1900

With the turmoil in Stock & Bond market, raging inflation, Fed rate hike, Russian-Ukraine war, the recession debate ( looming or not, 10Y-2Y, 10Y-3M yield curve inversion ) and all the bad news from financial media, it’s easy for investors & traders to fall into recency bias and project the bad news & downtrend long into the future.

But over here at this blog, we examine the market conditions & signals instead of reading/reacting to news. So what does market signal conditions and signal tell us? Market signal/Conditions dictate probabilities. Probabilities dictate outcome.  The conditions say that outright reversal / big bear market rally is a high probability set-up ( currently ongoing )

Reader might ask what would it be  ( outright reversal or big bear market rally ?? ) , we can distinguish bear market reversal &  big bear with below 2 simple criteria,

Criteria 1: Higher swing high: Break and hold above 4300, bear market is over. ( higher high is achieved )  

Criteria 2 : Higher swing low: Preferably hold above 3800 when market retrace and retest.

If the above 2 criteria is achieved, bear market is over.

Market signals and conditions  will be split into the following sections,

Section 1: S&P 500 price chart

Section 2: Market breadth

Section 3: Sentiment

Section 4 : Growth vs value

Section 5 : Seasonality

Section 6: Additional intermarket signal ( pending )

Let us dive deeper into each section to examine the market further,

Section 1: S&P 500 price chart

<SPX price chart>

There is a inverse head and shoulders pattern in the chart, suggesting reversal of near term downtrend. Subsequently pink downtrend line was violated and form a bull flag, price seems to  break out of bull flag by Friday 28th Oct US market closing time. In the coming session, we will see if hold above 50 days and 100 days SMA.

<SPX & RSI divergence>

Immediately after October 13th CPI release, many were expecting a further breakdown from 3500 level, but instead what happened was,  market gap down and rally above 3500. This is a very telling sign, when what should happen doesn’t ( aka WWSHD ), i.e. Bad CPI was supposed to crash the market but market didn’t crash. This is a total opposite of what happened in the market immediately after September 13th CPI release.

Also, RSI formed a divergence, when market “crashed” lower to 3500, RSI was forming a higher low. This suggest downtrend momentum has slowed and could possibly rally higher.  

On 28th September, Europe CPI was bad ( previous bad Europe CPI also affected US stock market ) and PCE release was bad ( Fed look at PCE instead of CPI for rate hike decision )

Finally, 3500 is a 50% fib retracement of Covid-Low to Dec 2021 swing high of 4820, a successful defense of this level is significant.

Therefore, Price signal suggest rally / possibly reversal.

Section 2: Market breadth

Next up we look at % of stock above 200 days MA and new high/new low , new 52 week low for signal from market breadth

<% of stock above 200 days MA>

There was a very subtle divergence, as market made a new low at 3500 level, % of stock above 200 day moving average was slight higher.

<new high-new low & new 52 week low >

New low and new 52 weeks low was shrinking When market made a new low at 3500 level.

Therefore, market breadth signal suggest rally / possibly reversal.

Section 3: Sentiment

<SPX - VIX>

Fear is subsiding and VIX is close below 28 , lower volatility will bring in buying flow from institutions that target VIX for buying/selling decision ( buy in lower VIX environment, sell in higher VIX environment )   

Therefore, sentiment signal suggest rally / possibly reversal.

Section 4 : Growth vs value ratio

<Value vs growth>

 Growth vs Value ratio is going higher across small, medium and large cap, as S&P 500 dip towards 3500 level. ( the only blemish is large cap dipping towards 1.92, will closely watch if it dip below 1.90 in the coming session ).

Small and medium cap growth has been bearing the brunt of market turmoil, but surprisingly small cap growth outperforming big cap growth relatively in recent period, this is bullish signal.

Therefore, growth vs value ratio signal suggest rally / possibly reversal.

Section 5 : Seasonality

Seasonally speaking, Oct – Dec is a strong period for stock market. And historically speaking, many Bear markets have ended in October, thus earning a Bear-killer month nickname for October. This is backup by historical data, coming from the creator of seasonality himself , stock almanac trader.

<Bear market bottom by month> source: almanac trader

Therefore, seasonality signal suggest rally/possible reversal.

Section 6 : Additional signal - Intermarket signal from Bond , US dollar, MOVE

Bond market was the ground zero, hardest hit area in this round of market turmoil., and it seems that the worst is over and is stabilizing. Similarly, US Dollar is stabilizing. I will elaborate more on this in the next article entry.  If the ground zero is stabilizing, other market can start celebrating.

To summarise, nearly all market conditions points to rally, I see plenty of dead bears in the coming session. Practice risk management and stay safe in the market.

My next 2 article entry will be,

1) Market explainer series : ground zero of market  turmoil - Bond market

2) Technical analysis series : reversal entry technique

Disclaimer : The information presented here are for research and education purpose only, and does not constitute investment advice, trading recommendation, author shall not liable for any action taken by any individual/company with regards to the information presented here or any part of the website - https://marketcycleedge.substack.com/