Each weekend, I study market behavior using sentiment and technical indicators. The goal is to use clues and indicators to determine if we are in a bullish, bearish, or sideways market environment.
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AAII survey (6/4/2014)
39.4% Bullish. 22.2% Bearish. 38.3% Neutral.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (6/3/2014)
62.2% Bullish. 17.4% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
CBOE Equity Put/Call Ratio: .50 (on 6/6/2014)
Bearish: Less than or near .50 is bearish (more call options are being bought).
Bullish: Higher than or near 1.0 is bullish (more put options are being bought)
VIX: 10.73 (on 6/6/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 is above its 50-, 100-, and 200-day moving averages, and pointing up on mixed volume. Nasdaq above its 50- and 100- day moving averages and pointing up.
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 zero line, and above 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 73.25 (on 6/6/2014)
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 2.59% (on 6/6/2014).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: What a difference a week makes! In one week, the sentiment indicators went from mildly exuberant to extremely exuberant (i.e. that is a bearish signal). Remember that it’s possible for sentiment to remain overbought for longer time periods, but we’re definitely in the danger zone. If you look at the market trend, however, we’re going up, up, and away, which is fooling many inexperienced investors (and a few pros, too), who think they are looking at a healthy bull market. I know I’m in the minority but I must disagree. The uptrend is your friend in a strong bull market, but we also have low volume (danger sign), obscenely high margin rates, and fewer and fewer stocks making new highs. Investors who do not study market history or are greedy will buy blindly at these sky-high prices, and that is happening now. Bottom line: Strange things are occurring in the market, which tells me that something will crack (if you have the patience to wait weeks or months).
Opinion: As I mentioned last week, I am still getting emails from some readers who believe my advice to move to cash is “dangerous” and “irresponsible.” Others are angry that I would dare suggest that the bull market might end. A few sent me emails bragging about how smart they have been, and that I am “crazy” for not buying stocks right now as the market makes all time highs.
A note to those who think they are stock-picking geniuses: When a market is rising on low volume, when the number of stocks making new highs is shrinking, when the sentiment indicators are flashing warning signs, when too many people think the market will never go down, GET OUT. (I have to ask: What happened to the buy low and sell high strategy? If you follow this idea, you will not be buying stocks at these lofty levels).
I also do not understand why it’s “dangerous and irresponsible” to warn investors that the market is overheating. If I’m right, I have saved them money. If I’m temporarily wrong, they lost nothing but a few percentage points. They can always join the gravy train later when prices come back to earth. On the other hand, if you believe the market will go up indefinitely and the Fed will prevent a bear market, I have some tulip bulbs I’d like to sell you at outrageously expensive prices.
All the indicators I look at (including some proprietary ones that I don’t publish) are signaling trouble ahead. Most people do not have the patience and discipline to wait for the first snap (i.e. inflection or pivot point). When it comes, it will catch most investors, including many pros, by surprise. I believe it’s coming sooner rather than later, but so far it’s taking longer than I anticipated. I have the patience to wait, however, and I’m comfortable making 0 percent (or in the red with my short positions) as storm clouds appear.
Bottom line: Only you can decide how much risk you are willing to take. If you strongly disagree with what I wrote above, do what you think is best, and ignore my warnings. The next few weeks could be very interesting. As for me, I am looking to see if the sentiment indicators go even higher this week (that will happen if the market keeps rising).
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.