stock market update

The fast drop on the news of the Chinese yuan devaluation has put the US stock market (as measured by the S&P 500) just at the lower edge of its February-August trading range. Any significant weakness below yesterday's low is likely to have very bearish implications for that reason.

But is the market likely to drop from here? 

First I want to observe that the devaluation itself is actually bullish for world equity markets. Why? To maintain a weaker currency the People's Bank of China will have to keep printing yuan, just as it has been doing to support the Chines stock market. This crypto-quantitative easing program will have bullish effects on world stock markets because it represents an increase in world-wide liquidity.

Turning to the market's technical condition you can see that two of my main three long term trend indicators for the US market are still above their 200 day moving averages (red lines in top three charts). Only the Dow is below its moving average and the Dow has by far been the weakest US index. My two out of three rule says this is still a bull market.

If you look closely at the third chart for the NYSE advance-decline line you will see that not only  is it still above its 200 day average but at yesterday's low it was still above its July 27 low, unlike the S&P and the Dow. This is a bullish divergence.

A similar bullish divergence is showing up in the 10 day moving average of the number of daily advances on the NYSE (fourth chart). This oscillator is well above its July 27 low also.

Finally, the bottom chart shows a five day moving average of the CBOE equity put-call ratio. High values show relative bearishness by short term traders and low values show bullishness. This put-call ratio is higher now than at any time during the past 9 months and is flirting with the highest levels it has seen in more than 2 years. I think this is a definite bullish indication going forward since it shows a lot of bearish trading sentiment.

All things considered I think the US stock market is about to begin a big rally. Betting on this prospect is a low risk proposition here because the market is close to its trading range lows (using the S&P 500 as the guide). A drop below the lows of the trading range would probably herald the start of a bear market.