The big news this morning is that our Psychology Composite that was P5 only a few weeks ago, suggesting that the stock market was due some short-term risk and volatility, has now improved to P3. At the same time, our Monetary Composite that had been in its most positive condition moved just barely across the threshold to M2. However, an M2 reading is still a very powerful signal that the Fed is going to do all in its power to resurrect a healthy economy.
We have been waiting on this positive shift in our Psychology Composite for the last three months, while the market indices have hung in there. Yet at the same time, the internal condition of the stock market was showing major weakness. For the combined S&P 500 and S&P 400, we saw the percentage of stocks trading above their 50-day moving average fall to less than 20% (reaching almost only 10% at one point), while the percentage of stocks trading above their 200-day moving average fell to almost 50%. You can see this action in the chart below.
History now suggests that unless this is a much more serious correction than those that typically occur during normal bull markets, the ratio of upside gains versus downside risk is most definitely on the bullish side of the aisle. Of course, the skeptics will tell you once again this is a major bear market evolving, and that the European mess is going to also bleed into our stock market. There is no definite proof that they are wrong; however, forty years of history suggests that with all of the catastrophes and problems of the past (and we've had our fair share during that time), each time we've seen conditions similar to today's (P3, M2 and V1), it has resulted in strong market action in the long-term.
Psychology is often a little early, but it is the best of our composites at pinpointing significant turning points.
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