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 (4/9/2014)
28.5% Bullish. 34.1% Bearish
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (4/8/2014)
54.6% Bullish. 18.6% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
CBOE Equity Put/Call Ratio: .70
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: 17.03 (on 4/11/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): All indexes are below their 50-day 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: MACD is above zero line, but 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 38.61 (on 4/11/2014)
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 2.62% (on 4/11/2014)
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 mixed: Retail investors are becoming increasingly anxious while many financial pros are extremely bullish. Even the pros who are predicting a short-term correction or pullback believe this year will be a positive one. Unfortunately, the technical indicators have taken a horrendous turn down, with the Nasdaq leading the way south. The 50-day and 100-day have been breached on all indexes. The bulls are nervously watching the 200-day moving average. Once again, the bulls and bears will struggle for control. The edge goes to the bears, but with the Fed on their side, the bulls will not go down without a fight. For five years, everything has gone the bull’s way, and they are not going to retreat willingly.
Opinion: It was another exciting week. As I wrote last week, the market remains dangerous. This is one of those times in market history when you need to pay close attention. There’s a strong possibility that a major trend change is occurring (or will occur in the near future). If I am correct, it will be easy to make or lose money quickly. This is not the time to to be careless or wrong.
Although I jokingly wrote last week that they will have to wheel Janet out to pump up the market again, it was no joke. The market fell on Monday, and on Tuesday Janet appeared out of nowhere like a fairy godmother with a magic wand. The magic worked and the market had a monster rally. Unfortunately, the good times lasted only a day and a half, and the market plunged for the next two days, moving lower than the previous low. (That is a flashing red warning sign.)
Because of the recent selloff, even long-time bulls are preparing investors for a 10 to 15 percent correction. Some money managers are telling their clients a correction is a natural, normal, and a healthy outcome. I believe this is the most predicted correction in recent memory, with seemingly everyone waiting for the inevitable pullback.
First of all, no one can predict when or how low the markets can go. That 15 percent correction could turn into a 30 percent crash if there is a perfect storm (Re: Ukraine). Also, although a 10 to 15 percent pullback doesn’t sound like much, that would be a drop of 1,600 to 2,400 Dow points. That’s not chump change. I wonder how many investors will stay the course if and when the Dow drops by a few thousand points. The answer? They won’t. If that scenario occurs, when the pain gets too great, and the market is falling fast, most investors will pull out in a panic (or threaten to).
Allow me to speculate: If the market plunges in the near future, I believe the Fed will step in again and do anything to rally the market (with a little help from Wall Street). If I’m right, there will be a rally that will blow the socks off of investors. Most important: If that snapback rally fails, then the market will get even scarier.
Right now, be prepared for anything. The puts I bought to test the market a week ago took me on a wild ride, but I have a profit (because of Thursday and Friday). I have slowly been building my short positions with nonleveraged inverse ETFs and put options (and I plan to take profits quickly). I am also buying call options to hedge (I use them to protect my short positions).
If you are new to the market, do not follow these shorting strategies because I could be too early. As I’ve said before, if you are not experienced, you should consider building up a cash position. In my opinion, making 0 percent in cash is better than losing 10 or 20 percent, or more. Too many investors with a buy and hold mentality are prepared to ride out the upcoming storm. I don’t agree with buy and hold during a dangerous market (although the strategy works well in a bull market).
Note: If you do move to cash, consider it a short-term strategy. If you’re holding cash, when the market environment gets more favorable (after many buy and hold investors throw in the towel, which could take a while), then you can look for bargains.
Those who bought stocks on the way up believe their profits are in no danger (perhaps they think the Fed will protect them). Many also feel their profits are so substantial there is little risk of losing much money. This is an unwise belief. The proper response is to get out at once when there is a major trend change (and the market takes a turn for the worse).
For now, look for end of day selloffs, intraday reversals, Fed announcements, and most important, failed rallies. All we can do now is watch. Also, look to see if the Dow goes below its 200-day moving average or bounces back like it’s done in the past. If it slices through the 200-day MA and stays there, that would be a signal to many investors to sell.
Bottom line: The clues are telling us there could be a major trend change. At the moment, we’re moving into a downtrend that started with the Nasdaq and could spread to other indexes. In my opinion, buying on the dip is too dangerous right now although some money managers are encouraging their clients to do so.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.