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
Note: The markets close at 1:00 p.m. ET on Thursday, and are closed on Friday, July 4th.
AAII survey (6/25/2014)
37.2% Bullish. 21.1% Bearish. 41.7% Neutral.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (6/24/2014)
60.2% Bullish. 16.3% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 11.25 (on 6/27/2014)
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.
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, but 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 64 (on 6/27/2014)
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 2.53% (on 6/27/2014).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: Sentiment indicators are still frothy, the VIX is at historic lows, and volume is low. The market started to sell off a number of times during the week but buyers stepped in to bring (i.e. manipulate) the market higher. Nevertheless, the market seems very heavy, as if it’s struggling to gain traction. The trend is still up, as reflected in the moving averages, a lagging indicator. MACD turned slightly down from last week. Except for the extreme sentiment indicators, we’re not seeing strong technical signals (yet). Bottom line: The market appears to be moving sideways. Eventually, it will have to choose one side or the other.
Opinion: The market acted odd all week. It sold off almost every day, especially at the open, but reversed direction to end each day with mild losses (or gains). The market seems heavy and sluggish, and is having a hard time rallying. Some veteran traders will tell you this is a sign of a weak market. If you listen to them, they will tell you the market is as dangerous as they’ve ever seen.
As you’ll find out soon, many current money managers have never experienced a bear market. These money managers were either in college or selling real estate during the 2007 bear market, and few experienced 2000, 1987, or 1973. History may not repeat itself, but human nature never changes. It will not be different this time.
There is a strong desire by many financial pundits to focus on good news, even when it’s not good. That includes having guests on financial shows who are perpetually bullish. Some of these guests make the following statements:
- “The market always comes back.”
- “When the market falls, it’s a buying opportunity.”
- “A correction of 10 percent is healthy.” (“It’s another buying opportunity.”)
- “You should never sell.”
If you believe any of the above statements, then your money may be at risk. Sometimes you have to do the opposite of everyone else, and this is one of those times. No matter how bullish the guests and hosts, no matter how they ignore the evidence, no matter how many times they put a positive spin on the numbers, it’s essential that you are objective. It is not easy in this environment. It seems like everyone is bullish.
Nevertheless, each day I see more red flags, and lately, I’m not the only one. Over the weekend, the Bank for International Settlements (BIS), criticized the Fed for its policies, and said that higher interest rates are coming our way. (FYI, this group correctly predicted the 2007 crash.)
In their report, the BIS warned the Fed about being too open about policy, which can make investors feel too “assured.” Here is a quote from the report: “This can encourage further risk-taking, sowing the seeds of an even sharper reaction. Moreover, even if the central bank becomes aware of the forces at work, it may be boxed in, for fear of precipitating exactly the sharp adjustment it is seeking to avoid,” BIS said. “A vicious circle can develop.”
Recently, I’ve noticed that more professionals are publicly criticizing the Fed for refusing to acknowledge inflation. Many are concerned the Fed is “behind the curve” and will be slow to raise interest rates as inflation increases. The Fed talks as if they want to increase inflation. (Be careful what you wish for, because you may get it.)
If I am right about this being a dangerous market, and I believe I am, the market is in treacherous territory. The sky is dark, storm clouds are appearing, and it’s only a matter of time before a thunderstorm (or hurricane) arrives. I am in awe that we have not had a significant correction for so long. Those who study market history know that the longer we go without a correction, the farther the market will drop.
There will be some extremely profitable opportunities in the future, primarily on the short side. This low volatile, sideways market can’t continue indefinitely. When snapping time occurs, and the market finally breaks, I’ll be ready (and I hope you are, too). Meanwhile, it can get boring while you’re waiting for the market to go somewhere. But patience is exactly what is needed to survive.
When the herd finally realizes the market is in trouble, the mad rush out of the exit doors will be spectacular. And that is why it’s essential you prepare for worst-case scenarios now before everyone else wakes up. By then it could be too late.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.