Guido's Weekly Market Notes: Important Market Lows Often Occur in October

Posted Monday, September 21, 2015 12:00 am

The Federal Reserve’s decision last week not to raise interest rates created another level of frustration for the financial markets. Yellen’s remarks were mostly upbeat about the U.S. economy, but she is concerned that recent global and financial developments could overflow onto our shores which could increase deflationary pressures from falling commodity prices.

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Volatility is anticipated to remain elevated in front of the jobs report on October 2 and third quarter earnings announcements in mid-October. The consumer discretionary and defensive sectors continue to exhibit the best relative strength. As a result we would expect the utilities, staples and health care sectors to behave best in the current environment. The consumer discretionary sector will continue to benefit from low inflation and a jobs market that has produced 5.5 million employment opportunities.

Over the short-term, we expect the bottoming process will continue into the early days of the fourth quarter with the risk to the recent low near 1865 and the reward to 2000 using the S&P 500. To help identify an investable bottom we would need to see two days where upside volume overwhelms downside volume by a ratio of 10-to-1 or more.

Additionally, the new low list should contract and the percentage of industry groups within the S&P 500 should expand above 40%. The timing is very difficult given the testing phase or bottoming process can last anywhere from a few weeks to a number of months. The good news is that historically October is often the month when important lows in the stock Draft market occur.

The weight of the technical evidence continues to argue on the side of caution. Stock market breadth that had been slowly deteriorating for most of the year turned negative in August. Market breadth continues to weaken with only 25% of the S&P 500 industry groups currently in uptrends.

This suggests that most areas of the market are in gear on the downside. Encouragement is found in two areas, investor sentiment and momentum. Fear has entered the equation as seen in a number of indicators of investor psychology. Although extreme pessimism is required to identify a market low when the trend is decidedly down, the level of fear is strong enough to begin looking for a market bottom.

Momentum remains problematic but since the panic low in late August downside pressures have weakened. The bottom line is that the technical light that turned from yellow to red in August remains in effect.