What Do You Call a Stock Market That's Oversold and Can't Rally? A Weak One – TheStreet.com

People seemed quite upset that the market turned lower Wednesday and didn’t rally. Me too. I thought we’d at least be somewhat flat to up.

But once again, the breadth of the market was barely red. I mean here is the S&P 500 down 19 points and market breadth is -100. The Russell 2000 was actually up all day, and for most of Wednesday, up nicely. I can’t change the Overbought/Oversold Oscillator; it remains oversold.

Is it possible we are oversold and can’t rally? Yes. That’s the sign of a weak market. What’s even more curious is that thus far the number of stocks making new lows has not expanded. Usually we see that number increase as the underlying stocks start to crumble. Only this time, it’s the big-caps, the ones that move the indices, that are falling.

Also worth noting is that the VIX was red most of the day on Wednesday and managed to eke out a gain. Despite the oversold nature of the market, I still think we are going to get some volatility in May and this chart is forming a “W.”

Russell 2000

Now, let’s talk about the Russell 2000. It is pretty typical when we see something outperform that the natural instinct is to believe it will continue that way. So let’s take a look at some of the longer-term indicators on this small-cap index. The first thing I want to point out is that the timing is elusive on it but it is worth tracking.

If we take the difference between the 50 and 200-day moving average lines on the Russell we can see that when the two moving average lines are coming closer together (those red peaks are making lower highs) it can be problematic for the index over the longer term. We saw the first lower high back in late 2004/early 2005 but it took a long time before those lower highs mattered. When they did, the 2008-09 bear market hit hard.

In 2015, we did not have to wait so long since that peak in 2015 vs. 2013 took the Russell down hard almost immediately. The current situation shows a lower high now vs. the peak in early 2017. It has been about 18 months since that first peak. Thus far the Russell does not show signs of weakening, but the writing is on the wall.

Now let’s move on to the chart of the ratio of the small-caps to the large-caps (IWM:SPY). It is my view that when it is rising the market tends to be more bullish than bearish. Point A on the chart was accompanied by that 2015 decline. Point B was not so much a decline as a giant sideways underperformance by the Russell for the first eight to nine months of 2017. Point C arrived in early October and the Russell 2000 promptly corrected.

Notice the box on the chart. That was the decline this year, until early March, when the small-caps began outperforming. They still are. But my point on this is that the decline in the market this year has been more about big-caps falling out of favor, which is why breadth has held up.

But now look at point D. It hasn’t rolled over yet. I have been eyeballing the blue line as the resistance zone, the point where I think this fails. If it does fail there, it will once again mean the small-caps are not the place to be.