Each weekend, I analyze market conditions using sentiment and technical indicators. The goal is todetermine if we are in a bullish, bearish, or sideways market environment. *
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AAII survey (1/22/2014)
38.1% Bullish. 23.8% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investor’s Intelligence (1/22/2014)
57.6% Bullish. 15.1% Bearish.
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
CBOE Equity Put/Call Ratio: .65
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)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 dropped below its 50-day moving average (but above its 100-day and 200-day MA), and pointing down.
Bearish (Downtrend): Index crosses below 50-, 100-, or 200-day MA.
Bullish (Uptrend): Index crosses over 50-day, 100-day, and 200-day MA.
MACD: MACD is above the 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: RSI is at 36.82 (on 1/24/2014)
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 2.73% (on 1/24/2014)
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: The selloff knocked some of the frothiness out of the market, but it’s still there. Sentiment readings (which were released before the recent pullback) were on the high side. Although the VIX spiked, it’s still in the complacent zone. More important, the selloff caused technical damage to the market as the S&P (and other indexes) fell below its 50-day moving average. Next stop: the 100-day moving average. First, we’ll see this week if the damage can be repaired. For now, the markets are starting the week with a bearish bias thanks to emerging markets. (Can Janet save the day? We shall see.)
Opinion: Little did I know how right I was when I wrote last week that emerging markets were going to crumble, and it would spread to the U.S. Although the indicators and clues were showing this would occur, I did not know when. I was surprised when the wheels starting coming off a few days after my post.
One important lesson: It doesn’t matter until it matters. In other words, although emerging markets were in trouble for a year, no one cared until the market started to sell off. Now you will read a thousand articles on why the market sold off. Guess what? It’s not important “why” the market sold off as that it did sell off. The selloff is an important signal.
As you know, Janet Yellen takes over this week at the Fed. It is going to be fascinating to see what the Fed will do. If they continue to taper, it will pressure emerging markets. If they stop tapering, there will be a short-lived rally (short-lived because it means the Fed has lost credibility). Personally, I don’t see how the Fed and other governments around the world are going to turn the markets around. Perhaps someone will pull a new program out of their bag of tricks and delay the inevitable.
Most investors are hopeful that the Fed will save them, but hope is dangerous for investors. In fact, hope can help damage your account if you let it. Instead of hope, be prepared for the possibility of a correction or bear market, but only if there is evidence.
To prepare (which I write about in my upcoming book, Predict the Next Bull or Bear Market and Win), consider scaling out of positions into cash. If you have losing positions, this is a good time to trim them or dump them if the losses are severe. If you have profitable positions, watch them carefully. Do not allow winning positions to turn into losers. This is also a time to consider buying protective put options if you believe the market is headed down (but this strategy is only for those who fully understand how to use puts). Aggressive traders can consider non-leveraged inverse ETFs (if there is evidence of a bear market).
Personally, I wouldn’t be buying on the dip in this market. The risk is too high. For now, it’s permissible to wait and see how this week develops. It’s possible that all the governments of the world will work in unison to support the market and the economy. If that happens, the market will rally. The real key is whether the rally (if one occurs this week) holds.
A popular theory by many money managers is that as emerging markets fall, investors will eventually find their way to the U.S. stock market. It’s a good theory, but if the market really unravels, my guess is investors will first move to the safety of Treasuries and gold (as they did on Thursday and Friday).
This is also not the time to panic. Only you can decide how much pain you can take if this selloff is significant. Because of the last selloff in June, many investors believe the market will quickly bounce back. In my opinion, the problems in emerging markets are deeper than anyone thinks right now. When this becomes evident, hope will turn to fear, and it could get ugly fast. A correction or pullback may or may not happen this week, but the odds are that it will happen in the near future.
Bottom line: Right now, there is a war between the bulls and the bears. As I said last week, I am leaning to the bear side, and until I see evidence of a significant reversal, I am sticking to that position.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.