Bull or Bear Market? (Week of May 12)

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.

JUST RELEASED: Understanding Options (McGraw-Hill, 2E) and Understanding Stocks (McGraw-Hill, 2E): http://bit.ly/1bl0ZNk

My latest book, Predict the Next Bull or Bear Market and Win (Adams Media), is available at any Barnes & Noble store, and on Amazon in May. Here is a link to the book and sample pages: http://amzn.to/1h1rZZu

My latest MarketWatch article: http://on.mktw.net/1mVFAX8

 

AAII survey (5/6/2014)
28.3% Bullish. 28.7% Bearish. 43.0% Neutral.

Bearish: If sentiment is over 50% bullish.

Bullish: If sentiment is over 50% bearish.

 

Investors Intelligence (5/6/2014)
55.8% Bullish. 19.7% Bearish

Bearish: If sentiment is over 60% bullish.

Bullish: If sentiment is over 60% bearish.

 

CBOE Equity Put/Call Ratio: .72

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: 12.92 (on 5/9/2014)

Bearish: Less than or near 12.

Bullish: Greater than or near 40.

 

Moving Averages (daily): S&P 500 is slightly above its 50-day moving average, and pointing sideways. Nasdaq below 50- 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 zero line, and even with 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 53.97 (on 5/9/2014)

Overbought: When RSI rises to 70 or above.

Oversold: 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 2.63% (on 5/9/2014).

Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).

 

Analysis: Once again, retail investors are saying they are neutral about the stock market, yet margin rates are at all-time highs. That is a huge red flag. On the other hand, financial writers (and many money managers) are excessively bullish, and nearing extreme levels (which is a flashing red sell signal). The VIX continues to show that option traders are complacent rather than fearful. Technical indicators are mixed, which is typical when the market is topping out. The Nasdaq is below its 50-day and 100-day moving averages, the Russell 2000 is below its 200-day moving average, and the Dow is still hanging on. Although the Dow is slowly churning higher, it is not healthy (even though it’s making record highs). Bottom line: Warning signs are everywhere. Caution is advised.

Opinion: The public is focused on the Dow so many believe that the worst is over. Although the Dow is making “all-time highs,” underneath the hood there is trouble brewing. As I write in my latest MarketWatch column (coming out later this week), it’s only a matter of time before the Dow follows the Nasdaq and Russell into a downtrend (and eventually into a bear market).

I am amazed that so many experienced investors and money managers are not seeing the flashing red warning signs. (Plug: I mention all of these signs in my latest book, Predict the Next Bull or Bear Market and Win). After six years, perhaps it’s easy to believe you’re a stock-picking genius, or that the market is bulletproof. Or perhaps they believe the Fed can prevent a bear market by inventing a cool new financial tool. The Fed can distract and delay, but it cannot prevent a bear market.

Being patient is difficult for most investors. It’s easy to hide your head in the sand and just hold stock positions. After all, the market has always come back before, and it might again. Unfortunately, the individual stocks you own might not.

I recently spoke with a former hedge manager and financial insider. This man is extremely knowledgeable about how the stock market operates. He confirmed what I have been saying for months: The market is in the danger zone and a correction or crash is inevitable. No one knows what the catalyst will be, but when it comes, it will be terrific. In his opinion, one of most revealing indicators are margin rates. Investors are borrowing money to buy stocks at higher levels than in 2008 and 2000. Not a good sign.

When the selloff in equities begins, it will be like a snowball rolling down the hill. The catalyst could be an economic event, a geopolitical crisis, or a spike in interest rates. It will cause the most knowledgeable and powerful investors to sell. Then the minions will sell, and the rest will be market history.

If you have followed this blog, I was cautiously bullish until six months ago, when the warning signs appeared. Each month, there is more evidence the market is getting more dangerous. Many investors don’t seem to recognize the signs. Perhaps they believe their fund manager will save them. Or perhaps they believe that they will be able to get out in time (like everyone else). Or maybe they think these warnings are like the boy who cried wolf.

I admit that after speaking with my knowledgeable friend, I have become even more cautious about the market. Although no one can specify when a selloff or bear market will occur, one is coming. I’m willing to remain primarily in cash for months until there is a significant sell signal. More than likely, it will start like this: One day there will be a huge selloff that comes out of nowhere. The financial commentators will struggle to explain why (and their reasons will be ridiculous). Don’t care about “why” the market is selling off on that day. The fact that it is selling off strong on high volume is significant.

I’m also going to make an educated guess that the buy-on-the-dippers will rush in to take advantage of the selloff. It’s the second wave of selling that will catch most investors off guard.

Judging by the puts I bought, it’s still too early to short (unless you want to speculate). Although some individual stocks in the Nasdaq and Russell 2000 are getting smashed, shorting is for experienced traders only. A less risky method is to slowly (and I mean slowly) buy a few shares of an inverse ETF. If the position is profitable, you can add to the position. If the position is unprofitable (8 to 10 percent), sell. Never add to an unprofitable position (with few exceptions).

Even though the Dow has made a series of record highs, fewer leading stocks are participating. In addition, volume has been anemic, another danger sign. Only you can determine whether to participate in this market or increase cash positions. If we do enter a bear market and you avoided losing money by reading this blog, I’d be delighted for you.

As I’ve said before, I’d rather give up 5 percent upside rather than risk 15 to 20 percent downside (or more). Once again, only you can decide how much risk you are willing to take. One last story: When I asked my knowledgeable friend whether he had any long stock positions, he looked at me and said, “Are you kidding?”

Bottom line: It’s not easy to sit on the sidelines in cash while other investors appear to be making money. In the near-term, the market could bounce higher. In the short to medium-term, caution is still advised.

 

* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.

I will notify you of my blog posts via twitter @michaelsincere

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