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In our Presidents’ Day report issued on February 15, we expressed our reasoning for the major indices bottoming and said that higher prices were immediately ahead. The major indices conformed to the expectations outlined in the report, and three days later on February 18, the S&P 500 along with the S&P 400, Dow Jones Industrial Average and the New York Composite Index generated short-term buy signals. The Dow Jones Transportation Index was the lead indicator and generated a short-term buy signal on February 12. This is not saying that a new bull market has arrived, nor are we are particularly bullish. Rather, OIA views the current rally as a move to equilibrium after the extreme degree of bearishness seen during the past 45 days.

Notably, the NASDAQ 100 and Russell 2000 have not generated short-term buy signals, and this continues to be a major negative for the broad market.

After generating short term buy signals using our protocols, markets have a tendency to pullback from 1-3 days and this is the opportunity to initiate bullish positions. In a very strong markets, prices continue to advance rapidly after the buy signal and then have the customary pullback from much higher levels. We do not envision this scenario for the S&P 500 and the more likely outcome is a sideways to lower trading pattern early in the week until a catalyst sends prices higher.

Occasionally, signals reverse immediately (3-7 days), but this is actually quite rare. However, signals in the S&P 500 E-mini did reverse immediately during November 2015 when the March S&P 500 E-mini generated a short-term sell signal on November 13 and then generated a short-term buy signal on November 19. This buy signal was reversed on December 11 when the March S&P 500 E-mini generated a short-term sell signal. The short-term sell signal was in place until February 18.

Typically, if a signal is going to reverse in a relatively short time-frame, it occurs after two or three weeks. One indication that the buy signal in the S&P 500 is about to reverse would be an extended sideways trading pattern that is characterized by a series of lower highs and lower lows. However, the canary in the coal mine would be if the NASDAQ 100 and Russell 2000 cannot generate short-term buy signals. A reversal of the February 18 buy signal would confirm that a test of the February 11 low is a virtual certainty.

For the rally in the broad market to continue, both of these indices need to generate buy signals, and though they out performed the S&P 500 since bottoming on February 11, they are major laggards year to date. For the NASDAQ 100 cash index to generate a short-term buy signal, the daily low (at least one) must be above OIA’s key pivot point of 4170.00 (February 19 close 4164.09). The cash Russell 2000 is in better shape as it closed above our pivot point of 1008.61 (1010.01 on February 19), but must make at least one daily low above the pivot to generate a short term buy signal.

On Friday, February 19, the S&P 500 had a shallow pullback, but we expect more of  a correction before the market resumes its uptrend. The pullback could extend to the 1885-1890 area, but should hold at the 1882.00 level. A close below 1882.00 would be very negative in our view, and likely push the S&P 500 down to 1862.00, which is the last area of support before a new sell signal is generated.

On the other hand, the more likely scenario is a move to the 50 day moving average of 1954.05 basis the S&P 500 cash index and 1946.30, the 50 day moving average for the March S&P 500 E-mini. If the S&P 500 cash index can make a daily low above the pivot point of 1932.60, we think the rally can continue to the 100 day moving average of 1999.47. For the March S&P 500 E-mini the pivot point is 1930.75 and the 100 day moving average is 1989.00.