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
My latest MarketWatch article: http://goo.gl/SJuzAW
AAII survey (7/16/2014)
32.4% Bullish. 28.5% Bearish. 39.2% Neutral.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (7/15/2014)
56.6% Bullish. 15.1% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 12.06 (on 7/18/2014)
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 sideways.
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 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 (S&P 500): RSI is at 58 (on 7/18/2014)
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 2.48% (on 7/18/2014)
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Money flows out of domestic stock mutual funds: Week of July 16: $1.o billion (Source: ICI)
Note: The week before, $8.8 billion was sold. Therefore, the selling outflow has been reduced during the last week.
Analysis: Because of the airplane disaster, the market sold off midweek but recovered. Sentiment is still high but not extreme, except for the VIX, which reflects investor complacency. The market moved into a short-term sideways market, which is why the indicators are indecisive. It’s anyone’s guess where the market will go during the week according to the indicators.
Opinion: It’s a dangerous world and a dangerous market. Volatility returned to the market for a day because of the tragedy in Ukraine and the conflict in the Middle East. By Friday, the market had recovered most of its losses but on anemic volume.
The week began with Janet putting on a good show, although she did receive some tough questions, including from Elizabeth Warren, who left Yellen almost speechless. Most people hope the Fed knows what it’s doing, but if they don’t, there will be hell to pay.
A good sentiment indicator for me are the negative emails I receive and the comments that are posted. For example, one gentleman wrote and said: “Why don’t you admit that you have been wrong about the market?” In my opinion, these are the type of emails you receive at market tops. The higher the market climbs, the more people believe it will never go down. Some bears are capitulating now, which is also what happens at market tops.
Here’s what I say to those who believe I am wrong: I might be early, but I am not wrong (not yet, that is). This is a dangerous market that is topping out. I cannot predict when it will reverse direction and plunge, but it will. It could be weeks or months. Because of the Fed’s experimental strategies, the market bubble could still grow bigger. The market may experience one final meltup that will force short-sellers to throw in the towel and give up. (Obviously, it’s always possible we could skip the final meltup and have a meltdown.)
As I observe the market, I see many danger signs. First, as the S&P 500 climbs, the number of stocks making new highs is decreasing. That is a red flag. Second, the decreasing volume is another danger sign. Volume is like gasoline for a car. If the market runs out of gas (i.e. volume), eventually it will stop climbing up the hill. However, that could take a long time. Because the Fed is still helping the market, it’s too dangerous to actively short. The most prudent choice is to move to the sidelines in cash. Suggesting that people move to cash infuriates some investors, which is why I get angry emails.
I don’t mind getting out of the market early and making 0 percent. But that is a choice each investor or trader has to make. If you can’t stand to make zero for a few months, then sitting and waiting in cash will be unacceptable to you. But I know that I’m in good company. Financier Bernard Baruch said that he made his fortune by “selling too soon.” And Jesse Livermore said that sitting and waiting for “snapping time” is very difficult for most people.
I also remember in early 2009 when many investors had been wiped out and vowed never to invest in the market again. They were afraid of more losses. I was not using many indicators then but others were. The indicators said that the market was oversold and was a buying opportunity. Few believed the indicators and followed their emotions: fear.
I might be early with my warnings but I’d rather be safe than sorry. A bear market is inevitable, and it’s coming to a stock market near you. As always, I am looking for signals and clues. The first clue is a two-day selloff on higher volume. Until that happens, you might as well go fishing. That day will come eventually, either in a rare crash or a 3 to 5 percent pullback (for starters). I am waiting for “snapping time,” which is the point when the market cracks enough so that the uptrend is disrupted. By then, almost everyone will have noticed something bad has happened. If you agree with me, all you can do is sit and wait, and watch.
Bottom line: Be patient and observe from the sidelines. If you must be in the market, manage risk.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.