I told everyone “Don’t Believe the Hype” after Monday’s market and this thinking may be coming to fruition. I don’t want to jump the gun on any predictions but that blog post stirred up more interest than any post I have ever written.

Today’s IBD “Big Picture” Section reads:
“Credit Crunch Fuels Sell-Off, Casts Doubt On Rally”

They mention that the rally, which was confirmed earlier in the week, is now skating on thin ice and is under pressure. To me, the follow-through was already on thin ice based on Monday’s NH-NL ratio; it has now cracked and may be falling through.

Anyway, enough of the shots at IBD because I still view it as one of the best stock market papers on the newsstand.

The NH-NL ratio currently sits at 168-524 or a negative 51.43% for the week (a stronger reading than the past two weeks).

Here is a look at the past three weeks:
07/28/07: 142-572, -60.34%
08/04/07: 85-529, -72.43%
08/11/07: 168-524, -51.43% (not including Friday)

For the complete list, please see this post: NH-NL Ratio.

What a difference a day makes for Headlines (The Media are Sheep):

Looking at the action on the NASDAQ and DOW, we can see how the indices are struggling to recover the 50-day moving average while bouncing above the 200-day moving average.

This type of action is clearly an indicator of buyers and sellers struggling to gain the upper hand. I won’t be the one to predict which group will win but I can tell you that I currently hold two long positions and one short position heading into tomorrow. So I guess I am playing both sides of the fence. I like my short heading into morning trading.

Either way, continue to monitor the recent market leaders and take the trades based on the setups and try not to form an opinion of where you THINK the market is headed. Just follow the market in the direction it wants to take. Sounds simple enough, now execute!

Investor’s Business Daily labeled today’s “Big Picture” Section:
“Dow Follows Through As Stocks Rebound On Volume”

Really? Which stocks lead this rebound?

The New High- New Low Ratio (NH-NL) closed at 77-1,003 on Monday, the weakest reading in five years (according to my data). The reading registered at (85.74%); yes, a negative 86%! Outside of the past two weeks, Monday’s new low daily reading was larger than any one weekly reading since August of last year. One day’s total new lows surpassed five days of lows of every week over the past twelve months (now that is telling us something).

The only lower reading that I can find over the past several years comes to us from May 10, 2004 when the ratio closed at 23-674 for a (93.40%) percentage reading. As you can see from the chart, that reading came when the market made an intermediate low and then bounced higher for a few weeks. Shortly after, the market dropped by 15% before staging another rally later that year.

IBD states that the recent market lows failed to undercut the previous low which makes the follow-through viable but I am not buying it. Financial and insurance stocks led the markets higher Monday; not the ideal groups to lead a rally.

More than 150 banking stocks made new lows Monday with the real estate group in a distance second with 66 new lows. Retail, medical and finance stocks rounded out the top five industry groups making the most new lows.

The total number of stocks making new lows during the week of March 10, 2007 was 727 (for all five days). That was the largest number of new lows in one week prior to July (late July averaged 2,700+ new lows per week). The correction in February was short lived and leading stocks were still near new highs and several of them continued to make new 52-week highs. The current environment looks different as leading stocks are breaking down and new lows are reaching extreme levels.

It will be interesting to see if the NASDAQ can hold the 200-day moving average and if it does, none of this research matters right now. However, a violation of the line is only a confirmation that this market wants to correct 15% or more.

Finally, 10 of the top 10 largest new lows happening in one day have all occurred over the past three weeks:
1. 1,003
2. 939
3. 744
4. 677
5. 580
6. 561
7. 560
8. 551
9. 345
10. 300

The largest one day drop this year, prior to July 2007 came on March 5, 2007 with a tiny 298 reading (doesn’t even make the top 10). The largest one day new lows reading of last year came on July 14, 2006 at 455 (this would only be number 9 on our list above).

Could this be a contrary indicator showing us a market bottom as it did in 2006? I don’t think so based on other market data and individual stock action.

Anyway, be careful and don’t drink the kool-aid because the new lows paint a completely different picture than the indices or the media!

The New High – New Low (NH-NL) Ratio plummeted into negative territory for the first time since early March and closed at its lowest point since July of 2006. Is it a coincidence that the ratio is dropping to its lowest level since the start of the most recent up-trend in July 2006? Could the NH-NL ratio be marking the beginning and the end of the strong run from 2006 to 2007?

*click the image for a larger view*

The 30% rise in the NASDAQ started in July 2006, precisely when the NH-NL ratio was building a base before blast off into a territory labeled strength on the accompanying chart. Aside from a few swings and a quick blip in February, the NH-NL ratio has stayed at or near the 80% strength calculation as late as the June 2007.

The NASDAQ corrected for four months in the spring of 2006, the same period of time that the NH-NL ratio decided to play see-saw in the area labeled “weakness” on the chart. The index did violate the 200-day moving average in the spring of 2006 so the downtrend should have been expected; so, we will now have to watch the present action to determine if the current market would like to follow a similar pattern.

The NH-NL ratio averaged a negative (32%) rating from May 20, 2006 to August 12, 2006 with a bottom reading of (76.64%) ending the week of June 17, 2006. Last week’s NH-NL ratio gave us an average of 572 new lows per day, the largest reading since I started tracking this information on the blog (several years). Last week gave us a negative percentage reading of (60.34%) which was better than June’s low but that was due to the higher number of new highs in the calculation. We only averaged 310 new lows per day during the bottom of the 2006 market, 45% fewer new lows than last week.

We had a reading of 79 new highs and 939 new lows last Thursday, one of the weakest readings I have recorded over the past several years. We must date back to the bear market of 2000-2002 to see these types of numbers. I will be searching my data for a reading of 1,000+ new lows in one day over the past several years to see what happened immediately following such an extreme level.

So what does this all mean?

It means that the market should be ready to correct by 10% based on the history of my NH-NL studies. I admit that my studies of this indicator only stretch this decade but they have been extremely reliable. Tie this together with the fact that crude oil is making new all-time highs and the fact that the NASDAQ and DOW are still near multi-year highs and a yearly gain hovering near 30%. The complete list of weekly NH-NL ratios are located at the bottom of this post (or through the link).

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I used a quote for my weekly MSW analysis from a fund manger from Oppenheimer Capital named Eugene D. Brody: “Sell stocks whenever the market is 30% higher over a year ago”.

The NASDAQ is currently 25% higher than it was in July 2006 and is trading in new high territory (the highest level in six years). Historically, markets retreat after making a 30% gain from one year to another and we must be on the lookout for a signal or a combination of signals and red flags that could lead to a correction or downtrend. I am long the market but I am always aware of market cycles and I will be watching for signals so I am not telling anyone to sell at this time but I am warning all investors to be smart and listen to history.

Like the NASDAQ, both the DOW and S&P 500 have made considerable gains from their lows in 2006. They are both up about 20% and have been riding their 50-day moving averages for the past seven months. The first possible red flag of a trend breakdown would be a major violation of the 50-d moving average among one or all three major indexes. The second major red flag could be the breakdown of the relative strength rating for the DOW or NASDAQ versus the S&P 500. I have highlighted the RS line on the DOW chart with the bottom representing a possible trend reversal and the top of the shaded area representing another leg of the up-trend (a fresh breakout to new all-time highs).

When reading the 2007 Stock Trader’s Almanac, I see that March represents the fifth best month of market gains over the past 100 years but has been volatile in the latest decade with large gains and losses. March has had a gain for the past eleven straight pre-election years and that is exactly what we are in right now. Take this with a gain of salt because price and volume is still the most important. The markets also haven’t experienced a down year during a pre-election year over the past 68 years. There hasn’t been a down year in the third year of a presidential term since 1939 (World War Two era). The only severe loss during a pre-election year was in 1931 (the depression) when looking at data than spans to the early 1900’s. During Bush’s last term, the market was 25%, 26% and 50% for the DOW, S&P 500 and NASDAQ respectively. This did happen during the fall of Saddam with the beginning of the Iraq war.

We haven’t had a stretch of strength for the NH-NL ratio as we have witnessed over the past four weeks since 2004 (almost three full years). We have not had three consecutive weeks of new highs averaging 500 or more new highs since 2004 and we didn’t have three out of four weeks with these types of numbers in 2005 or 2006. We had our second best week since December of last year with new highs averaging 556 per day and new lows only reaching an average of 42. I must point out that this was a short week due to the President’s day holiday but the strength must be noted. It was the third time this month that the weekly highs averaged more than 500 per day. February of 2007 has been the strongest month for the NH-NL ratio since early 2004. Is this a sign of things to come or is this a topping signal? I read it as a trend and the trend is higher and until that is violated, we stay long!

Weekly New High – New Low Ratio (NH-NL) for 2007:
Saturday, January 6, 2007: 279-67
Saturday, January 13, 2007: 344-39
Saturday, January 13, 2007: 281-46
Saturday, January 27, 2007: 316-55
Saturday, February 3, 2007: 502-45
Saturday, February 10, 2007: 558-53
Saturday, February 17, 2007: 428-48
Saturday, February 24, 2007: 556-42 – This past week (a short week)