BofA's Head Technician Calls For Market Correction

BofA's chief technical research analyst Mary Ann Bartels has released a note in which she demonstrates the bullish and bearish technicals currently in the market (although with the only thing mattering anymore is when and how big any given Fed permanent open market operation will be, we question the utility of technicals even). While Bartels is still holding on the a call for a "deeper equity market correction" while noting the obvious ("The equity market this year has frustrated both the bulls and the bears, and this is likely to continue into year-end, in our view") she points out that the broader market signals are mixed. She points out that "most short-term indicators have generated a sell signal and Net Tab is not oversold. We still need to break and hold above S&P 500 1150 to invalidate a potential head and shoulders distribution top. A test of the July low (1010) is still not ruled out. A break above1150 would point to a test of the April high of 1220." Today's action shows just how hard the market is trying to breach the upside resistance and disprove all the economic fundamentals that unequivocally point to an ongoing and accelerating deterioration in the economy. Below are the key charts supporting Bartels' call.

First, observations on volume:

On-balance-volume measures positive and negative volume flow and is used as a gauge of accumulation and distribution. Similar to the S&P 500, NYSE consolidated tape on-balance-volume is testing key resistance. This resistance is at the February low and June high and a break above this area is required to improve the pattern for volume.

On the recent shift in AAII sentiment, which as we pointed out previously has gone from a contrarian bullish indicator to contrarian bearish.

Since February 2006, the upper boundary for the ratio AAII US Investor Sentiment Bullish Readings to AAII US Investor Sentiment Bearish Sentiment (AAII Bull/Bear ratio) has been 2.00-2.50. Readings within this range have suggested that individual investors have become too bullish on the US equity market. Last week’s reading of 2.10 is within this range and a potential contrarian bearish sign for the US equity market.

On the complacency suggested by the recent put/call ratio

The 5-day CBOE put/call ratio is trending lower and approaching the late July/early August levels that proved to be  contrarian bearish for the US equity market. A falling put/call ratio suggests investors are becoming more complacent.

Inflows into leveraged short ETF are contrarian bullish

The risk is these ETF investors are too bearish & the rally continues An increase in assets of leveraged short US equity  ETFs over the last one to two weeks suggests that traders in leveraged US equity ETFs have become too bearish. These investors have increased their short exposure as the market has rallied. This is a contrarian bullish signal that suggests that the rally from late August is set up to continue.

However, as it has been long demonstrated that for the most part these are natural hedges to other underlying positions, we are not sure how much one can extract based on this kind of information.

Hedge fund net long/short exposure

Long/short hedge funds have reduced market exposure to about 18% net long vs. the historical average net long market position of 35-40%. A risk to our call for a deeper market correction is that long/short hedge funds increase their market exposure back to the historical average. In our view, this would support the market and reduce the risk of a deeper correction.

What large spec CFTC COT data indicates

The risk to our call for a deeper equity market correction is that large specs cover their shorts and provide a floor for the market. Large speculators slightly covered shorts in S&P 500 futures to a net short of approximately $12.8bn notional  from about $13.1bn notional previously. Readings are neutral.

On bullish MACD

Weekly MACD, an intermediate-term trend/momentum indicator, generated a buy signal as of 10 September 2010. This is a potential market positive.

Ratio of Stocks vs Bonds

The February low, June high, and August high are the lines in the sand for stocks vs. bonds. Above this resistance suggests the potential for a more sustainable period of outperformance for stocks relative to bonds. The stocks vs. bonds ratio remains below the February low, which is key resistance.

Bad news from fins

The Financial sector is still not providing market leadership and this is negative for the overall US equity market. Within the financials, the banks, regional banks, and securities broker-dealers remain weak relative to the broader US equity market. Stronger areas within the sector are REITs and insurance. A lack of leadership from banks, regional banks, and broker-dealers is a headwind against a sustainable breakout for the US equity market.

Offset by slightly better news from tech (i.e. China)

The good news is that Technology held a relative chart support vs. the S&P 500. Since Technology is the largest sector within the S&P 500, this is a potential market positive. But, Technology still has significant overhead resistance on the relative price chart that must be cleared to establish a stronger leadership trend. We continue to like Technology from a longer-term perspective, but on a tactical basis, the sector has not provided market leadership since topping out vs. the S&P 500 in December 2009.

And now for what is really imporant: free money, courtesy of helicopter Ben:

After a period of negative growth for MZM money supply, the 13-week annualized rate of change for MZM turned positive  in late June. In our view, this is a supporting factor for the US equity market. From December 2009 into April 2010, MZM
money supply saw the worst contraction on a 13-week rate of change annualized basis since the 1980s. YoY growth for MZM reached -9.29% on 19 April 2010, exceeding the prior lows from May 1988 and May 1994 of -6.87% and -6.47%, respectively. As of 06 September 2010, the YoY growth rate on an annualized 13-week rate of change basis was 6.8%.  This improvement from the April lows is supportive for the US equity market.

And here are the top 100 stocks either overbought or oversold based on BofA's OBOS relative price momentum model.

At the end of the day, all of this is moot. The only question that matters: in an environment of ever lower volume and participation, the daily flooding of the market by the Fed's now almost daily POMOs which is by and far the biggest marginal mover, will keep pushing stocks higher until all connections with reality break and the whole thing plunges.

h/t Ken