Distribution Day #1
Cycles Strategy for Investors
On Wednesday the hawkish tone of the Fed Minutes spooked the market, as the minutes mentioned a lack of progress on reducing inflation. Thursday morning, NVDA gapped up on an earnings beat (released Wednesday after the close) and the news of a stock split. The broader market gapped up as well; however, sellers stepped in at the highs, causing the market to reverse lower on heavy volume. What is interesting is that all sectors fell together. This is the first sign of distribution, and although the market recovered, we need to take note that this was Distribution Day 1. According to the work of William O’Neil and Investors Business Daily, the market often experiences 4 to 6 Distribution Days within 4 to 5 weeks before a reversal.
Let’s see how this played out in previous reversals. In this analysis we assume: 1) a Distribution Day occurs when price is down for the day and volume touches or exceeds the 20-day average volume line (grey) and 2) a Reversal occurs when price drops below and stays below the 21 Exponential Moving Average (blue).
April 2024 Reversal: There were 6 distribution days within 4 weeks before the April 2024 pullback. Looking at the chart below notice that most of the distribution days (except the last one) occurred as price was above the 21 EMA. As institutions were selling out, the RSI and CCI indicators showed bearish divergence, while MACD had a bearish crossover and a red histogram.
July 2023 Reversal: Before the 7/27/2023 top there were 4 distribution days in 4 weeks before price trended below the 21 EMA. Also notice that the distribution days all occurred as price was above the 21 EMA. Meanwhile RSI and CCI had bearish divergences, as MACD had a bearish crossover and red histogram.
February 2020 Reversal: It should be noted that event-driven drops, like the Covid-19 drop in February 2020, did not give much forewarning. There were only 2 distribution days 4 weeks before the drop. Nonetheless, the RSI, MACD and CCI indicators did a good job of telling us that the market turned bearish.
Now we know what to look for before a change of trend. Unless there is an unexpected event that shocks the market, there are usually 4 to 6 Distribution Days in 4 to 5 weeks before a market reversal while above the 21 EMA. The RSI and CCI indicators often show bearish divergences, while the MACD shows increasing bearish momentum. What typically follows is the market breaks below and trends below the 21 EMA as the pullback or correction occurs.
Market Conditions
We did say in our Midweek Update that the RSI for the S&P 500 (SPY) was overbought and a pullback to a moving average is possible. We got exactly that as the SPY pulled back to the 9 EMA. Buyers stepped back in on Friday and price remains above all moving averages.
The market remains in an uptrend, however we do see some concerning signals. Global Liquidity (black) continues lower. There were Net New Lows over the past 2 trading days. Finally today’s candle is considered an “inside day” so the verdict as to whether we continue to new highs or experience more selling is still not final. On the positive side the RSI indicator and McClellan Breadth Oscillator are recovering. The VIX dropped almost 7% today, telling us that the recent uptick in volatility was due to hedging for NVDA earnings. The Percent of Nasdaq Stocks Above the 5 SMA (known as the FOMO Indicator) is falling hard, however it is approaching low extremes and could produce a powerful rally when it reverses.
We noted that the Russell 2000 (IWM) has relative weakness. Looking at the chart below we could see that it was unable to make new highs and finds itself in a wedge pattern. If this breaks the lower wedge line, it could produce a powerful selloff. On the bright side, it held above the 21 EMA.
Strangely, the Dow Jones Industrial Average (DIA) is looking very weak. It fell below the 21 EMA and seems to have broken below its uptrend line. It is still above its 55 EMA for now. With small caps and large-cap value weak, we believe that large-cap growth will have a larger portion of the upside if the rally continues.
Retail puts still need to be washed out, so the Retail-Only Put/Call Ratio points to more upside for this uptrend. However, when retail gets heavily invested in bullish call options, the market will be vulnerable to a 19%+ correction as we are near a 4-Year Cycle peak. This will be covered in the Premium Section.
Conclusion
With Distribution Day #1 in the books we can assume that there will be 3 to 5 more (4 to 6 total) of these days before the market is ready to reverse trend. That is unless there is a news event that abruptly shifts sentiment, similar to the Covid-19 drop. For now the market is still above the 9 and 21 EMA so the trend is still up and currents are with the bulls. Bearish traders who short the market now will probably get squeezed for a bit. However we believe that June will be a more rocky month than May is.
In the Premium Section today, we’ll go over our Cycles Strategy for Investors, where we review the Intermediate, Annual, 4-Year, and 18-Year Cycles. We’ll also provide our June cycle forecasts for the S&P 500. Note that our monthly cycle forecasts for our top 12 asset classes (S&P 500, Nasdaq 100, Russell 2000, the Volatility Index (VIX), 10-year Treasury Rate, Investment Grade Bonds, High Yield Bonds, US Dollar, Crude Oil, Gold, Silver, and Bitcoin) will be provided next week. Next week, we’ll also send our Founding Members annual forecasts for these 12 asset classes until the end of 2024. This is a must-read for passive investors who seek to avoid huge drawdowns and make life-changing money over the next 5 to 10 years.
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