All Clear for Stocks—Really

06/03/2010 1:30 pm EST

Focus: MARKETS

John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says several technical indicators are giving positive signals for stocks after the recent nasty sell-off.

An “urgent selling” signal is given when the ratio of the number of down days to the number of up days reaches or exceeds four to one over a period of 15 days or longer.

The idea behind urgent selling is to identify periods in which the selling has been climatic and/or reached unsustainable levels, and it is quite good at its job. [In 1979 the late Jim Alphier] outlined its long-term track record and noted that of special interest were groupings of three or more urgent selling signals in a relatively short period.

[Recently,] at the lows we got within one down day of an urgent selling signal when the 16-day ratio rose to 76.5%, a narrow miss. If it were a clear signal, it would be the third urgent selling signal in 18 months; the others having occurred in October 2008 and in March 2009. This combination is a setup with strongly bullish implications.

Some confirmation is already evident; the action in the VIX is particularly telling, and we are ready to be quite bullish, awaiting market confirmation such as an indication that Euroland worries are no longer topic one. These could be combined in a “sign of strength” that occurred on a day of bad Euroland news.

A sign of strength is a rally day with greater-than-average gain and/or greater-than- average range and volume. In fact, May 25th was a minor sign of strength, but given the recent turmoil, we’d like a bit more convincing display to confirm. (A sign of strength was issued on May 27th, which we take to be an “all clear” signal for the market.)

PowerShifts look for the market to be severely oversold and then demonstrate enough strength to potentially break the back of the down trend. PowerShifts are relatively rare and almost never come in clusters. Currently on the chart of the [Standard & Poor’s 500] there are three PowerShifts within a week—[May] 21st, 25th, and 27th. I have never seen anything like that before and must conclude that it is at minimum a bullish fact and perhaps something more.

I have to be careful here because the picture is so bullish that it is hard to contemplate a negative outcome, yet of course a negative outcome remains a real possibility. We have a well-confirmed W bottom in place that arrived in the wake of a correction from a well-confirmed high in the market.

Leadership is developing in the basic materials and technology areas that ought to have some legs. The correction in the price of crude oil and the subsequent corrections in energy stocks have created another important opportunity to buy the energy stocks.

We especially like the drillers that have been battered by the current crisis in the Gulf and the oil service sector. We view energy stocks bought at these depressed levels as long-term strategic holds.

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