Due for a Rally

11/28/2007 12:00 am EST

Focus: MARKETS

Dan Sullivan

Editor, The Chartist

Dan Sullivan, editor of The Chartist, made predictions last week that seem prophetic now, as the market picks up much-needed steam…

While we remain in the bullish camp, it is not a pretty sight out there. Since closing in record high territory on October 9th, the Dow has lost over 1,154 points, -8.15%. The Value Line Geometric and Russell 2000 were the hardest hit, losing in excess of -11% over the same time frame. Obviously, the subprime fiasco is the main culprit with the financial sector under extreme selling pressure. Since the beginning of the year, the main casualty among all of the industry groups has been mortgage investment, which has been an absolute disaster. Surety and title insurance is another disaster area. Next in line to the downside is residential construction.

As this is written, most of the widely followed averages have dropped under their 200-day moving averages. The Russell 2000 and Value Line Geometric as well as the Advance Decline Line have also dropped below their August 16th closing lows while the Dow and benchmark S&P 500 are within striking distance.

There is no question that the path of least resistance is to the downside with the number of new highs contracting and new lows expanding dramatically. The high-low differential, which is a 10-day moving average of 52-week highs versus 52-week lows, is close to a 3-year low exceeded only by the readings generated at the August lows. On the positive side of the ledger, the sharp contraction in interest rates with the intra-sensitive Dow Jones Utilities, which often leads the market at pivotal turning points, refuses to buckle under the overall selling pressure. In addition to this, the market is intensely oversold relative to many of the most recent bottoms.

The Chartist overbought/oversold indicator fell to a low of -4.69% on Monday, November 19, the fifth most oversold reading recorded during the current bull market cycle. The indicator is based on the 19-day exponential moving average (EMA) of the Value Line Geometric Average. Whenever it falls 3% or more under its 19-day EMA, the market is considered oversold on a short/intermediate basis. From these levels, the odds favor a market reversal.

Since the bull market started on October 9th, 2002, there have been only a handful of oversold readings similar to now.

At current levels, our overbought/oversold indicator is telling us in no uncertain terms that a substantial rally is way overdue.

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