The stock market is arriving at an interesting juncture as noted in our conference call yesterday (video summary here ) and one that we at The FRED Report have been looking for since early August . This formation is known as a "divergence bottom," and it means that certain momentum configurations on our proprietary indicators suggest a market will make higher lows in momentum, combined with lower closing lows in price. This formation is somewhat unusual, because high momentum is needed to generate the first part of the signal, but there have been other examples in other markets this year.As an example, we show the weekly chart of SLV, and note the decline off of the highs in early May. The speed of this decline created the same momentum condition as the decline in the stock market in the first two weeks of August. Notice how SLV traded in a range and them moved down to make new closing lows in the last week of June/first week of July -- around six to seven weeks later.
We give another example of this type of formation, which occurred after the crash of 1987. Notice that the low in price for the move occurred in October of 1987, while the closing low of this move occurred in December of 1987.
Now, we turn our attention to the current stock market, as represented by the SPY. The closing low was 112.64 the week of August 19, 2011. It is five weeks since then, and we are in position to make a new closing low. These often happen within five to seven weeks of each other, so we are in the window of time for this to occur as well.
As of this writing, the SPY has not made new closing lows for the move. But several indexes are in position to do so. We show charts of IYT, IWM and the NYA. The Transports are important because they are so economically sensitive, and while the extra weakness is a concern, it will fulfill the pattern. IWM is 2000 stocks (as opposed to 500), and it is close to fulfilling the pattern. The last chart is the NYA (2200+ common stocks). These also can fulfill this pattern.
The close this week will be interesting and we acknowledge that significant fundamental and macro risks remain. But, from a technical standpoint, given our forecast of early August, it is likely that the market's risk reward profile has improved. >To order reprints of this article, click here: Reprints
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