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
AAII survey (8/20/2014)
46.1% Bullish. 23.7% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (8/19/2014)
49.5% Bullish. 16.2% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 11.47 (on 8/22/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 is above its 50-day moving average, and pointing up. The Dow is above its 50-day MA and 100-day moving average, 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 even with its 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 62.59 (on 8/22/2014)
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 2.40% (on 8/22/2014)
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 bulls needed to win back those 600 lost points and they did. Technical indicators are bullish and sentiment indicators are positive but not extreme, except for the VIX, which reflects extreme complacency. Put another way, no one expects the market to plunge. If you are bullish, you couldn’t ask for a more ideal setup. On the other hand, the geopolitical problems keep getting worse. In addition, although the bulls won the week in spectacular fashion, the market’s reaction to Janet’s speech was a big yawn. According to the indicators, we enter the week with the bulls in charge. The potential party poopers are geopolitical events spiraling out of control, or a failed rally (i.e. unable to hold S&P 2000). Although the bulls are feeling optimistic, caution is still advised.
Opinion: The bulls took control of the week beginning with a 185-point blowout on Monday, which helped keep the market higher most of the week. On Friday, there was a small pullback after Janet’s Jackson Hole speech. Few understood what she said, which is probably how the Fed (and the market), likes it.
As you read above, the short-term trend is up and there’s a good chance the S&P will hit 2000 this week. Dow 17,000 and S&P 2,000: It has a nice ring. I wish I could join the party and tell you that it would be a wonderful time to buy. But I can’t. As I’ve written before, I am more than willing to give up the 5 to 7 percent upside to avoid losing a potential 20 percent or more on the downside. I know I’m in the minority with this view as many long-time bears are giving up. The main reason to be bullish: The Fed. As long as the Fed is using depression-era policies to keep interest rates low, then betting against the Fed is as dangerous as going long.
Here are a few thoughts:
1. Although the market has done a good job of ignoring all of the geopolitical problems, the problems aren’t going away. In fact, it will get worse. One day, the market will have to deal with it, but not yet, it seems.
2. I always thought that the first rule of investing is “buy low and sell high.” With the S&P and Dow making all-time highs, buying at these price levels contradicts that strategy.
3. Although the Fed has trumped all the indicators, and will continue to do so until further notice, the complacency among market participants is incredible. No one expects a correction anytime soon (how soon they forget). On the contrary, one fund manager said that we just survived the 2014 Correction, so it’s full speed ahead. Note to Fund Manager: A 3 or 4 percent pullback is not a correction.
4. The time period (August to October) is traditionally the weakest three months of the year. If the bulls can get through this period unscathed, the bull market will continue, but at even more dangerous levels, in my opinion.
With the Fed running the show, the only thing the bulls have to worry about is what the Fed will do. I know this experiment is not going to end well but at the moment, I can’t say when. There are clues the market is overbought and at dangerous levels, but until reality sets in, all you can do is sit and wait. Bull markets don’t last forever, especially markets that bubble higher and higher on nothing more than what the Fed might or might not do.
In my opinion, it’s too dangerous to short, but it’s also too dangerous to go long. As for me, I’m comfortable sitting on the sidelines until we get that first snap, i.e. a 50- to 75-point plunge in the S&P.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.