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 right now. Here is a link to the book and sample pages: http://amzn.to/1h1rZZu
My latest MarketWatch article: http://on.mktw.net/1pbAqU7
AAII survey (5/28/2014)
36.5% Bullish. 23.2% Bearish. 40.3% Neutral.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (5/27/2014)
58.3% Bullish. 17.3% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
CBOE Equity Put/Call Ratio: .56 (on 5/30/2014)
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: 11.40 (on 5/30/2014)
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 65.73 (on 5/30/2014)
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 2.46% (on 5/30/2014).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: Many sentiment indicators are reaching the tipping point, especially Investors Intelligence, which is a survey of financial writers. In addition, the VIX is near a six-year low, which reflects overwhelming complacency among option buyers. The VIX tells us that option traders are not expecting surprises. So far, they’ve been right (but as a contrary indicator, it’s a warning sign). In addition, RSI is near overbought levels. In other words, sentiment is on the frothy side. However, moving averages are telling us the market is still in an uptrend. If you’re a bull, the chart is your best friend right now. Unfortunately, the higher we go and the frothier it gets, the market will eventually top out and reverse. Bottom line: The market is giving hope to the bulls and the bears, but so far, the bulls are winning.
Opinion: I’ve been in contact with a number of experienced, independent traders who are astounded at their proprietary technical indicators. It’s as if the market is on another planet, and for many old-timers, it’s a huge red flag. A lot of things aren’t making sense. First, bonds are rallying along with stocks, which shocked many fixed income traders. (Bonds were supposed to get crushed). Volume in the stock market was so low last week it seemed no one was participating, and yet, the market went up. That’s a red flag. The fear that money managers have of missing out on the next rally is another red flag. When too many people are in a buying panic, afraid to miss out, it usually doesn’t end well.
It’s true that the bulls have had their way for five years with a little help from their friends (the Fed). Most bears are laying low, biding their time and managing risk. Although this market is not going to end well, to manage risk, you must not short at the top. After all, the market can still go higher from here. In my opinion, the risk is so extreme right now that cash is the only prudent move to make. Obviously, many disagree with me (a large majority of investors are bullish). Buying inverse ETFs is also an effective strategy but only for experienced traders who are willing to take some short term pain (and cut losses if market goes against them).
Right now, this market is frustrating to both bulls and bears. The bulls are not getting the returns they have come to expect (10 percent or more), while the bears are losing money. If I’m right about the market (that it’s reaching a breaking point), here’s what you are looking for: Wait for a large down day in the S&P 500 that doesn’t immedately reverse. In other words, you might get a two-day selloff that isn’t extreme, but does make everyone take notice. If that occurs, that would be a signal that more pain is coming.
Sitting and waiting for an inflection (or pivot) point takes tremendous discipline, especially if you are bearish. If you’re bullish, however, try not to get trapped on the wrong side of this market. Perception can change quickly, and Wall Street is filled with the stories of those who could not get out of the market in time. If I’m right, snapping time is coming, but it could take a few weeks or months (or a year although I highly doubt that). As always, look at the market for clues. One thing is for sure: the lack of volatility and volume is a red flag, and the more red flags, the more dangerous the market becomes.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.