Dead cat bounce possible Wednesday

Dow daily

Ya gotta love Robbie the Robot. Last night he warned us of the perils of crossing the S&P 200 MA and sure enough today we were treated to some ugly losses across the board, with the Dow taking a 266 point nosedive with a solid red candle.

Take a look at this daily chart - yesterday the S&P crossed the 200 MA, and today the Dow followed suit. No support, no test, just badda-bing, leaving us at 11,867. This not only broke the 200 MA support, but the June support of 11,894 too. From here there's no more support until the March lows around 11,614. That's just 253 points from here. We dropped more than that today alone.

Further support lies at 11,450, 11,200, 11,000, and 10,680. But we don't care what happened, we want to know what's going to happen tomorrow, Wednesday. Let's look at the bull and the bear arguments.

Dow losing streaks

Today put the Dow on an agonizing eight day losing streak. Which brings up the question of how long can this go on? You may recall I addressed the issue of market streaks in this post last year. Today I did the analysis over again, this time using Dow daily closes all the way back to October 1st, 1928 rather than just the last 10 years. And what were the results? Well, in 20,802 sessions, the longest continuous losing streak in the Dow was... drum roll please... ten. And that only happened once

There were three streaks of length 9, and just 4 (make that 5 after today) of length 8. So the odds of this losing streak going longer than 8 tomorrow are just four out of 20,802. As I mentioned in my post just this past June on weekly losing streaks when we were down six straight weeks, this is the kind of number you really want to think about betting against.

And back in June, sure enough, the Dow did not go down an additional week. And those odds were only 5 in 4,264. But historical arguments are like counting cards in blackjack. No matter how high the count swings in your favor, you could still lose the next hand. Still, you have to wonder...

The technical indicators 

Adding to the bullish case is the state of the technical indicators. The Dow's RSI hit zero, yes zero. And it hit that yesterday. It remained there today. It literally doesn't get any more oversold than that. The last time the RSI hit zero was on July 2, 2010, following 10 straight losing days (OK, there was one day in there that closed 5 points higher which prevented the run from truly being 10 long, but the idea is there).

Anyway, what happened next? The Dow took off on a 7 day rally. In fact, July 2, 2010 was the exact day that the longer term uptrend began, lasting all the way until this past May. There is one big difference though. Back then at that point, we had been below the 200 day MA for 7 sessions. Today marked just the first close below it. Still, you have to wonder...

The other indicators are equally oversold. The Dow momentum was -721 today - that's the one there that looks like it's falling off the bottom of the chart. Money flow and the stochastic are also highly oversold.

 The VIX

Meanwhile, there's some possibly significant guidance in VIX land tonight. This VIX rose today to close at 24.79. However, today marked the third day it put in a lower high. The last three VIX intraday highs were: 25.94, 25.63, and 24.79 (today). Just as importantly, today's candle was a textbook bearish hanging man. And today the VIX exited its ascending regression trend channel of July 22nd. That is a bearish setup (remember, bearish for the VIX is bullish for stocks).

And today the VIX broke away from its upper Bollinger band. Finally, all of the VIX indicators are as oversold as they've gotten on past VIX peaks. The short stochastic in particular executed a bearish crossover today. This is looking to me like not a bad entry spot for a position in XIV, the inverse VIX tracking ETF.  And it implies that if the VIX is truly poised to go lower, the market will perforce go higher.

Morningstar Market Fair Value, 3 year

Finally, let's check out the Morningstar Market Fair Value graph (which you can see on their web site here).  Yesterday's ratio was 0.93.  I expect today's number (not out yet) was lower.  And remember July 2nd, 2010?  Well that was the day the Morningstar ratio hit its low during last summer's ugly spot.  The value? 0.90.  We're getting pretty close to that now.

The Bear Case

So that's the bull case.  The bear case?  Well, it seems to consist entirely of the fact that in the last two days all three major indices (Dow, SPX, and Nasdaq) crossed below their 200 day moving averages.  But the thing to remember, is that while this is bad, very bad, it's not instantly fatal.  Look back at May 20th last year.  That was the last time the Dow took a real dive straight through its 200 MA.  The next day was up.  Of course it then went on to put in further lows, but the day after the plunge was up.

The bottom line

I'm kind of expecting this same scenario for tomorrow.  At the moment, the market futures are essentially flat.  The ES is actually up by a scant 0.08% at 1:50 AM EDT.  Which doesn't mean there isn't more downside to follow.  I think there is.  But I also think that we're in for a short bounce, dead cat style, most likely tomorrow (Wednesday) and possibly extending into Thursday.  That's all she wrote (whew, that's enough!)