Each weekend, I study market behavior using sentiment and technical indicators. The goal is to use clues, observation, and indicators to determine if we are in a bullish, bearish, or sideways market environment.
RELEASED: Understanding Options (McGraw-Hill, 2E), Understanding Stocks (McGraw-Hill, 2E), and Predict the Next Bull or Bear Market and Win (Adams Media): http://bit.ly/1bl0ZNk
AAII survey (7/27/2014)
31.1% Bullish. 31.1% Bearish. 37.8% Neutral.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (7/29/2014)
55.6% Bullish. 16.2% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 17.03 (on 8/1/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 is below its 50-day moving average, and pointing down. The Dow is below its 50-day and 100-day moving averages and pointing down.
Bearish (Short-term Downtrend): Index crosses below 50-, 100-, or 200-day MA.
Bullish (Short-term Uptrend): Index crosses over 50-day, 100-day, and 200-day MA.
MACD (S&P 500): MACD is above its zero line, and below its red 9-day signal line. (Note: I’m using the settings, 19,39,9, recommended by Gerald Appel, MACD’s creator.)
Bearish: MACD line crosses below 9-day (red or gray) signal line. MACD line (black line) crosses below zero line.
Bullish: MACD line crosses above 9-day signal line. MACD line crosses above zero line.
RSI (S&P 500): RSI is at 34.29 (on 8/1/2014)
Overbought (i.e. Bearish): When RSI rises to 70 or above.
Oversold (i.e. Bullish): When RSI falls to 30 or below.
Note: RSI can remain overbought or oversold for extended time periods.
Bonds: U.S. 10-year yield is at 2.47% (on 8/1/2014)
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: Last week was the worst week for the S&P 500 in two years. In two days, it wiped out all of its year-to-date gains. As a result, technical damage was done to the major indexes including the Dow, which is now below its 50-day and 100-day moving averages. In addition, volatility was introduced back to the market as the VIX climbed from an extremely complacent 12 to a mildly complacent 17. Because of the pullback, sentiment fell across the board, although most in the financial world are still bullish. In addition, RSI dropped dramatically, and is almost in oversold territory. Keep in mind that many consider this a “healthy” pullback that will set the stage for a retest of Dow 17,000 or S&P 2000. Fact: This week will give us important clues where this market is headed.
Opinion: As I predicted, it was a heck of a roller coaster ride. To be blunt, it was a horrible week for the bulls, and real technical damage was done as the indexes breached their 50-day moving averages, and the Dow dropped below its 100-day moving average. And yet, it is too early for the bears to claim victory. After all, we have seen this story before.
For five years, the market has always found a way to reverse direction and move higher. For example, the Fed could introduce a new program such as “Operation Twist and Shout.” That could repair the psychological damage and delight the minions. If the market sells off even more, the Fed could bring out QE4, or suspend tapering. Any of the following actions would send the market to dizzying heights, at least temporarily.
Yes, technical damage was done to the market last week, but it’s also too early to say that a correction has begun. First, keep your eye on the rallies. If the market rallies this week, and it will try, watch if the rally is successful. Successful means that it is able to win back much of the losses sustained last week, and eventually rise above its moving averages. A key price point is 1960 on the S&P 500. If the S&P rises above that price level, the bulls will still be in control.
On the other hand, if the market attempts to rally, and fails, look out below. Even more revealing, if Janet tries to woo the market higher and it doesn’t work, and sells off, that is also significant. The worst-case scenario for the bulls is if the market rallies and fails, or if it plunges right at the beginning of the week. That would catch most investors off guard, and give notice that a correction is underway. This could play out over several weeks or months.
Many pundits are saying that a 5 to 10 percent correction in the Dow is “normal” and “healthy” and will be a “buying opportunity.” Perhaps. If they’re right, an additional 1,600-point plunge (10%) can’t be a pleasant experience for investors. In fact, most investors are still complacent, and cannot fathom the possibility that the bull market is in any danger. If this is a true correction, years of gains could be wiped out in a short time period.
If you’ve been reading this blog, you are already prepared. If you are a beginner investor, you may be sitting primarily in cash, and that’s prudent. As many investors learned last week, making 0% is better than losing money. If you are an experienced investor, you are looking for opportunities to short the rallies using inverse ETFs or options (I don’t recommend shorting individual stocks for retail investors).
Bottom line: This is the time to bring your A-game to the market. If there was ever a time to study and observe the market for clues, it’s now. Although the market is vulnerable, the Fed, with help from Wall Street, might say or do something dramatic to try and keep the party going. All we can do is wait and watch, and be ready for any scenario.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.