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See Is This the Best Stock Market Indicator Ever? for a discussion of this technical tool.

The charts below are current through the week’s close.

Monthly OEXA200R Over the Past Few Years

Interpretation:

The OEXA200R ended the week unchanged at 88%.

Of the three secondary indicators:

• RSI is POSITIVE (above 50).
• MACD is POSITIVE (black line above red).
• Slow STO is POSITIVE (black line above red).

Commentary

According to this system the market is tradable.

The “Printing Press Bull Market” continues. It could be seriously argued that since 2009, Fed intervention in its various forms has for all practical purposes simply camouflaged a second full blown Great Depression. Realistically however, Fed Chair Bernanke can only feed the economy so many cans of QE Red Bull before it eventually crashes. Consider the following realities:

• After five years GDP remains feeble. 
• U6 (actual) unemployment is over 14%. Many of the long term unemployed will never gainfully work again because they have either gone on disability or their skills are so rusty that employers will never hire them for the equivalent of their former positions. For many of those lucky enough to find work it doesn’t provide as much income as their old job did.
• The gusher of money coming out of the Fed hasn’t yet caused overall inflation to increase, true – just inflation of the stock and now housing markets. But how can a country print an ocean of new money out of thin air attached to a stagnant GDP without eventually causing inflation? It’s never happened before in history and it won’t happen this time.
• Southern Europe is in a full blown modern Great Depression, unemployment and other indicators make that clear. The relatively healthier economies of northern Europe continue to drag that ball and chain behind them with no end in sight.
• The events in Cypress have been nothing short of eye-popping. The global banking system is built on solid faith that depositors can park their savings in an account and have it protected from robbery, as opposed to hiding their cash in a mattress. Cypress, however it turns out, has severely undermined that faith. The idea that a bank can engage in the financial equivalent of internet gambling, reap enormous profits if the gamble succeeds (not to be shared with depositors, of course) but can without warning raid depositors’ accounts if the gamble fails, ignoring deposit insurance and myriad law is mind boggling. And this idea had the quiet approval of the I.M.F. (meaning, the U.S. government). As hair brained as the Cypress precedent is, similar “bail-in” noises are even coming out of Canada.
• But really, how fragile is the economic picture? Here’s one indication: Atty. General Eric Holder (for Pres. Obama) recently stated that he would not criminally pursue the mega-thieves at Bank of America, HSBC and other too-big-to-jail banks because it would just be too “unsettling” for the economy. The Attorney General is afraid to enforce the law against the largest, most dangerous financial criminals in world history, that’s how fragile it is.

The force driving the S&P to new highs is not actual economic recovery but mass delusion. The idea that no matter what – hell, high water, incompetence or criminality – the U.S. Government will do whatever it takes to keep the systemic banks afloat. That, and the assurance that the Fed will also go to any economically irrational extreme to keep Wall Street and those banks happy (since those banks ARE the Fed, that’s no surprise). All in the slim hope that if the bogus appearance of recovery and prosperity can be maintained for long enough, actual recovery and prosperity will somehow materialize in time. But in the certainty that either way those who control Wall Street and the systemic banks will continue to make a fortune.

The recent bull market in the S&P is based on the same mass speculative self-delusion that has characterized every other financial bubble since the Tulip Mania of the 17th century. Will the market crash next week or next month? Probably not. But all the other bubbles eventually ended, and in the same way that this one eventually will.

Background on How I Use This Indicator

The OEXA200R is a valuable metric used to accurately assess the state of the market in order to make profitable trading decisions. That is, whether we are in a bull, a bear or transitioning from one to the other, as well as market volatility and risk within each of those situations. Historically, it has also given traders a clear early warning signal of impending serious market downturns and later safe re-entry points. While not intended as a day trading tool per se it can certainly be used as background information by day or highly speculative traders. Simply put, the OEXA200R gives traders the ability to identify the most opportune conditions within which to execute their various long, short or hold strategies.

Following a major market correction, the conditions for safe re-entry are when:

   a) Daily $OEXA200R rises above 65%

And two of the following three also occur:

   b) RSI rises over 50
c) MACD black line rises above red line
d) Slow STO black line rises over 50 and is also above red line

Without the solid foundational support of two out of three secondary indicators it is unsafe to trade even if OEXA200R edges above the 65% line. Once two turn positive, the market is considered safely tradable as long as OEXA200R remains above 65%. Volatility and risk for long traders are relatively low. The trend is on their side.

When Daily OEXA200R drops to 65% it is taken as the conservative signal to exit all long positions, sit on the sidelines with your cash and wait for some clarity before proceeding. Volatility and risk increase substantially. Since 2007, this has often been a “tipping point” condition presaging a major market drop.

If the OEXA200R does not rebound but remains below 65%, how to proceed depends on the overall trend of the market, the macro-picture. During the cyclical bull of 2003 to 2007, the market was still safely tradable with OEXA200R in the 50% to 65% zone because there was enough upwelling lift in the S&P at that time to minimize the chance of a sharp, significant market downturn.

The problem is that we can by no means confidently compare our present situation to that of 2003 – 2007. There is no strong, steady wind pointing the market weathervane in one direction, it is being buffeted by swirls and gusts in unpredictable ways. To better understand this, take a look at the charts below, in particular the overall trend of the OEXA200R during the 2003 – 2007 cyclical bull compared to the trend from 2007 to present.

The S&P chart indicates that for the past five years we have not had a steady upwelling trend in the market comparable to 2003 – 2007. Absent that underlying support, the OEXA200R has undergone significant gyrations since 2007. Notice also that even in spite of the Fed-fueled rally, the S&P volume has experienced a steady decline since 2009, a classic Bear indicator.

If the OEXA200R drops below the 50% line we regain clarity as to the market’s direction. That will be the strong signal to exit any remaining long positions immediately in expectation of a serious, imminent market decline. Conversely, it will also be the clear signal to go short to take advantage of that sharp decline.

In my opinion, the most significant indicator of where we stand today is the fact that the market is above both its 140 year historical trend line and the trend line for the secular bear that began in 2000. These are the marco-forces that will gravitationally pull the market back into equilibrium at some point in the near future.

How far will the market drop? QE3 might save the day once again, temporarily. But in light of the factors mentioned above, it should come as no surprise if by 2014 we end up experiencing a market event worse than that of 2008 – 2009. Luckily, OEXA200R should give us ample advance warning of the next major correction however we want to trade it. Buckle up!

Note: Stockcharts.com offers free access to the $OEXA200R indicator on a daily and weekly basis. The monthly view requires a subscription. Stockcharts allows users the option to download the last two years of indicator data. Unfortunately, I have not found a source for longer-term $OEXA200R data for performance back testing. Meanwhile, here is a link to a chart that gives a better look at the correlation between the $OEXA200R and the S&P 500 over the past decade.

(c) John F. Carlucci