December 1, 2021

Selling intensified over Tuesday and today with increasing volume making it all the more conspicuous. The Nasdaq is in a 6.0% correction from peak to trough, yet the subsurface damage is considerably worse.

In the Nasdaq, there have been three distribution days in six sessions. The real tip-off that something might be amiss came on the seven-day rally of mid-November.

As outlined in Twitter, the best way to gauge a market's health is not to look at a decline. It is to look at the quality of an advance following a decline, specifically its breadth, volume, and leadership. As noted at the time, the mid-November rally had poor breadth, good volume, and sketchy leadership.

Breadth during this rally was the key, i.e. the advance-decline figures for each day. They did not hold up as well as the S&P and Nasdaq did.

The chart below is a different look at the advance's breadth. Here, we are using a proxy for stocks in a long-term up trend, the percent of NYSE stocks above the 200 ma. You can see it has been lagging for months. At present, just 36% of NYSE stocks are in long-term up trends. (NYSE breadth data is better for long-term analysis than Nasdaq data.)

The view here is that the market selling is more a function of uncertainty over the seriousness of the Omicron variant of Covid 19. Some could point to rising interest rates as the catalyst, however the 10-year note yield has actually been falling lately, from 1.69% to 1.43% in just four sessions. This may indicate concern that Omicron may force some countries to institute lockdowns, hampering economic growth.

While this could easily be the beginning of a new bear market, what is more likely is further new highs by the S&P, unaccompanied by confirming new highs in breadth indicators such as the NYSE advance-decline line. The public blog post shows a period of at least a few months of breadth divergence prior to a primary bull market top.

Yet that research is based on the NYSE advance-decline line -- not the NYSE stocks above their 200 ma, which has diverged from the S&P for nearly 10 months.

Of course the market can do anything it wants to do. Which is why it is best not to operate with any preconceived notions as to what may happen.

With the averages at lows for this six-day selloff, and with no pattern setups for the long side, a 100% cash position is called for.

Short Selling

I have discussed in the past how shorting should only be done in a bear market -- or what has the markings of a bear market. This means our two long-term signposts: 1) a breadth divergence, and 2) an interest-rate proxies (banks, brokers, insurers) divergence with the S&P. Those are in effect.

At present, the market is too extended to the down side to consider any short sales. We will look for the averages to rally before expecting shorts to materialize. I have a universe of 212 computer software names that I started reviewing for possible shorts. This consists of the various MarketSmith software stocks priced at $15+. Inverse ETFs do not show enough of a trend yet to be considered attractive.

In summation, cash is king. The breadth divergence of this bull market -- when defined by the percent of NYSE stocks above their 200 ma -- began when the growth sector topped in mid-February. While my research on breadth divergence is limited to the NYSE a-d line, it is possible that there has been enough decay in the broad market that we are in a new bear market in the averages.

Let's continue to study the averages, former leaders, and potential new leaders every day. Leadership changes most often occur during a correction or bear market.

Kevin Marder

Trading Lessons
Introduction to the service video (38:00)
Money management and risk management video (20:27)
Bread and butter pullback video (11:10)
Bread and butter pullback: Pt II video (15:09)
Bread and butter pullback: Pt III video (31:48)
Bread and butter pullback: Pt IV video (30:16)
System R
Short-selling video (25:53)