2 Ways A Bull Market Ends

The S&P and Nasdaq’s break of their
50-day moving averages took its toll Tuesday, as the broad market
sold off sharply and turnover increased across the board. The major indices
gapped down modestly on the open, trended steadily lower throughout the day,
then finished near their intraday lows. Small and mid-cap stocks, which may have
begun losing their relative strength, sustained the worst losses. The Russell
2000 Index
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0.8%, but the Dow Jones
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The Nasdaq Composite
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worse if not for the impressive relative strength in the Semiconductor Index
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. Oddly, the $SOX was the only industry sector we follow that closed higher on
the day, albeit only by 0.1%.

Volume finally picked up yesterday, indicating a return of
institutional activity on the sell side. Total volume in the NYSE jumped 18%,
while volume in the Nasdaq increased 21% above the previous day’s level. The
substantial losses on firmly higher volume made yesterday a clearly defined
“distribution day.” Unfortunately for the bulls, it marked the fifth
“distribution day” in the NYSE within the past four weeks and fourth in the
Nasdaq. While one to three days of institutional selling is normal within the
context of bull markets, stocks typically have a very difficult time recovering
from the overhead supply of four or more “distribution days” within a four-week
period. If the technical damage on the charts is not enough reason for bulls to
pull in the reins, the high number of “distribution days” flashes a clear red
flag.

Historically, most bull markets come to an end, or at least
sustain a sharp correction, in one of two ways. The first is when the number of
“distribution days” increases to more than two or three within a month (as
discussed above). Second is when former market leaders begin to lose their
strength and break support. As you probably noticed, recent market action has
seen both of these scenarios occur. Former market leading stocks such as GOOG,
AAPL, and NTRI have all lost their relative strength and have failed to recover
from the break of their 50-day moving averages. Worse is that we have begun to
see a complete lack of leadership within any industry sector.

Since the new year began, two of the strongest sectors have
been Gold Mining
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losses yesterday. The $GOX collapsed 7.6%, causing the index to break support of
an uptrend line that had been in place since mid-December. Similarly, the $OSX
plummeted 6.1% yesterday and broke support of the neckline on the bearish “head
and shoulders” pattern we have been discussing over the past two days.
Considering we have been short OIH (Oil Service HOLDR) since February 3, we were
obviously pleased with the ETF’s one-day decline of nearly 9 points! The daily
chart of OIH below illustrates the break of the neckline at the $146 level, as
predicted in yesterday’s Wagner Daily. Also, note the recent days of
higher volume selling (aka “distribution”):

Despite yesterday’s huge loss, we expect further downside in
OIH because of the specific chart pattern. When a stock or ETF breaks the
neckline of a “head and shoulders” pattern, it’s predicted decline is typically
equal to the distance from the top of the head down to the neckline. Looking at
the chart above, you can see this equates to a range of 11 points, or 7%.
Therefore, a downside target on the OIH short would technically be 7% below the
neckline, or a price in the $136 area. We have found the “head and shoulders”
pattern will follow through with this predicted drop about 60% of the time.
However, note that support of the 50-day moving average is presently just over
$138, so that level may be a safer place to take profit or at least tighten your
stop.

If we were forced to pick one industry to buy, Semiconductors
are probably showing the most relative strength right now (outside of the
Chinese stocks and ETFs). However, we do not advise fighting the overall
market trend. It makes no sense to go long the only sector that is holding up
when you can easily short just about every other sector. Trading with a
“top-down” mentality is usually the safest and most profitable way of
positioning yourself. This means that one must first be sure to trade in the
general direction of the market before determining which individual sector and
stocks to trade.

The S&P 500 broke support of its prior low from January
yesterday, causing the index to form a “lower low” on its daily chart. This
means the S&P has now formed both a “lower high” and “lower low” on its daily
chart, technically forming a new intermediate-term downtrend. The daily chart of
SPY (S&P 500 Index) illustrates this:

The break of the 50-day MA created a lot of overhead supply
and yesterday’s break of the prior low created more. Therefore, we expect the
S&P to have a very difficult time putting in any kind of significant rally
attempt in the short-term. Just as water flowing down a hill always follows the
path of least resistance, so does the stock market. Even if the bears take a
rest, it would require a lot of demand to absorb all the supply that has been
created over the past two weeks. Needless to say, our overall bias on the broad
market remains on the short side. In addition to OIH, we remain short SPY,
currently showing a 1-point gain from our entry point, and XLU, which is showing
a small profit on the short side.