Image Source: Pexels

The short-term downtrend looks set to continue, and now the PMO index has reached all the way to the bottom of its range. Meaning, if you're trying to profit from the market's short-term cycle, it is a bit late to be selling in order to protect profits and raise cash. However, if you think a larger market sell-off is brewing, then it isn't too late to sell in order to protect capital.

In the short-term, the major indexes are clearly trending lower and are below their 5-day averages. Last Saturday, it looked like the short-term downtrend was more of a sideways consolidation, but the sideways action quickly turned downwards starting on Tuesday, and we now have a nice pullback in prices that has the potential to set us up in a few weeks for another short-term run higher.

It is really hard to think about buying while the market is doing so badly, but it always feels this way while the PMO is at the bottom of its range. The real challenge is to gather your courage in order to buy at the cycle lows when the short-term downtrend is getting close to bottoming out and transitioning back to a short-term uptrend.

It isn't a matter of if and when there is a cycle low, it is just a matter of when, because we know for certain there will a low in the downtrend that transitions to an uptrend.

The bullish percents are pointing decisively lower again, and there is plenty of room to move lower before leveling out.

Last week, I mentioned that there was a potential bull flag in the SPX chart and that if it were to break down, then that would be another market sell signal. We got that additional sell signal on Tuesday, and now the uptrend line is being challenged, or perhaps it has been broken depending on how you draw the line. Based on the position of the momentum indicator, it certainly looks like the move lower has further to go.

The NDX also looks like it has further to fall based on momentum. I mentioned a few weeks ago that the 12,000 level was a line in the sand, and that if it violated this level, that it would suggest a gloomier, larger trend outlook for the market in general.

However, looking at this chart now, the pullback to 12,000 doesn't look so bad and resembles a normal consolidation of gains, so perhaps 12,000 was a bit aggressive on my part as a line in the sand? I'm going to suggest moving the line in the sand to the 11,000 level, and a breach below would necessitate taking further action to protect capital.

This chart of the buy-write indexes does a great job of indicating when a downtrend has started in earnest because the indexes fall below their 5-day averages when the market really starts to sell off.

If the market is just listless and pausing, then these buy-write indexes will continue to show strength even when the market indexes are not. So, when they broke down on Tuesday, it was another indicator saying that the selling was getting serious.

The number of new 52-week lows increased quite a bit this past week, and the level of new lows on the Nasdaq is worrisome. I don't think you would see this many new lows even on the Nasdaq in a bull market, and it seems to me like early evidence that the larger trend is a bear market rally.

However, in the shorter-term, because there was a lot of selling in the market, an increase in these new lows is to be expected. So, we can also use this chart to help figure out when the selling is excessive and indicative that the cycle is close to a bottom.

One thing that I like to point out about this chart is that the real value comes from seeing a lot of new lows while the market appears to be strong. When the market looks healthy, but there are a lot of new lows, it is a major warning sign because it reveals market weakness hidden behind the strength in the indexes.

In other words, if the PMO is at the top of the range and there are a lot of new 52-week lows, then it may be time to get defensive in your accounts.

This chart is a little disappointing for the bulls. It would have been nice to be able to see prices pull back while the 5-day average of total news remained in the blue because that would have hinted at underlying strength. However, I'm not sure how much to make of this dip into the red just yet.

There has been much talk about yields rising again after some disappointingly strong inflation reports, and of course, it makes sense to see market weakness while yields are rising. But so far, yields have only risen into previous resistance levels. If they continue to rise, then I think we have some more serious problems in the stock market.

Also, let's not overlook that in this chart you can see that the 5-year yield is higher than the 10-year yield, and the 10-year yield is higher than the 30-year yield. That's an inversion pointing to some issue in the economy, or in the world itself. Somewhere there is an issue causing the yields to invert, and I doubt the issue is something to be dismissed easily.

I'm not a buyer of energy stocks, what with the price of oil declining or moving sideways as it has been over the last few months. However, I'm also a bit optimistic about all other stocks when oil is behaving this way, so this chart favors the bulls at the moment.

I should also point out that in my lifetime, it is unusual to see the Fed raising rates while oil prices are behaving so well. Usually, the price of oil is the root of all inflation evils.

I am back into my short of European stocks. They had been holding up surprisingly well, and I was too early when I shorted a few weeks ago. I had to cover, but a breakdown began to appear late in the week and so I'm short again. I'm not recommending this to anyone, but I am willing to say what I am doing with my accounts. You have to decide for yourselves, of course.

Bottom Line

The short-term cycle continues to play out regardless of the larger bull or bear market trend. However, knowing whether or not it is a bear influences how aggressive I am long or short.

In a strong bull market, I wouldn't short stocks during a short-term downtrend. I would just raise cash when the PMO is at the top of the range and deploy cash when the PMO is at the bottom of the range.

On the other hand, in a bear market, when the PMO is at the top of the range, I'm eager to buy inverse 3x ETFs and profit from the move lower, but I might also buy long 3x ETFs when the PMO is at the bottom of the range because I know there can be some very profitable rallies within the bear.

In a bear market, I'm still focused on the short-term trend, but more importantly, I'm protecting capital. That means that I might have to sell longs if the indicators turn particularly bleak.

My weakness in a bear market, and I'm sure I am not alone in this, is to be tempted to short the market when things get really bad. It isn't a good thing to do because there is always a sharp bear market rally ready to appear. The time to short in a bear is when the PMO is rolling over from the top of its range.

At the moment, my accounts are 50% long and 40% short. Considering the strength of the selling this past week, I'm surprised by these percentages. 40% short seems at first to be a little low, but then again, it may be about right considering there is no indicator screaming to sell.

But 50% long indicates that not that many stops have been hit. As I scroll through the stock charts, there are still quite a few stocks showing very good price action and there are some strong sectors, as well.

I own a number of small-cap building and construction stocks. They are doing well and haven't sold off as hard as the rest of the market. This ETF shown below shows the strength in the group, starting in September or so, but it also shows that the rally has been up to and just under resistance. A lot of the weekly charts of the various industries look just like this.

I'm not a buyer with the chart looking like this, but I am optimistic because of the positive price action of the leading individual stocks in the group, so I am willing to hold and just let them stop out on any weakness. If this ETF were to break above resistance, I would be adding to the group.

Outlook Summary

• The short-term trend is down for stock prices as of Feb. 9.
• The economy is at risk of recession as of March 2022.
• The medium-term trend is uncertain for Treasury bond prices as of Feb. 4.

More By This Author: