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.
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AAII survey (10/1/2014)
35.4% Bullish. 30.9% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (10/1/2014)
47.5% Bullish. 15.1% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 14.55 (on 10/3/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 is slightly below its 50-day moving average, and pointing up. Note: The Russell 2000 is well below its 200-day moving average and is in a correction.
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 slightly below its zero line, and below its red 9-day signal line and pointing down. (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 45.80 (on 10/3/2014)
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 2.45% (on 9/26/2014)
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: It was a volatile week for the markets. The Russell 2000 entered into a correction with a 10 percent YTD loss. The Dow ended the week in the red although it was saved from the abyss by a Friday rally. The S&P 500 is slightly below its 50-day moving average, but it could have been a lot worse. Because of last week’s volatility, retail investors lost some of their hubris (sentiment fell), but professional investors remain bullish. Financial writers are also in the bullish camp, and Friday’s job reports helped make them believers (although the data was mixed). Not surprisingly, cracks keep appearing. For example, technical indicators such as MACD turned down. All of these mixed signals is a clue the market is still dangerous.
Opinion: If you only watch the Dow, as most people do, you may think that all is well. After all, although the S&P was down for the week, the Friday blowout rally gave hope to the bulls, who do not want to believe the party has ended. But if you dig below the surface, there are a lot of red flags, some of which I mentioned above.
Brewing beneath the surface, you have the Ebola virus. This virus must be kept under control, or the emotional, physical, and economic damage will be severe. You already know of the other geopolitical problems, including Hong Kong, which could get messy. Any of these events could turn into a Black Swan.
This week will tell us if Friday’s rally was a one-day wonder or the continuation of the uptrend. In my opinion, jumping in the market at all time highs with low volume is too dangerous. Yes, the market could go higher, but based on sentiment and technical indicators, I believe we’re topping out. It will take a lot of buying power to move this market higher, which is why I’m watching and waiting.
If the market sells off during the week, it will confirm this market is topping out. A tremendous amount of energy was used to keep the market from falling last week. What I mean by energy are massive computer buying programs. I can’t say who is doing all of the buying at key times during the day but it’s not retail investors.
The next week (and the next two months) are extremely important. This is the time to bring your A-game to the market. In addition, keep your eye on the bond market, which may create future problems. It’s also fascinating that commodities are getting crushed.
It seems as if the investing world is split into two major camps. The bulls believe the market will keep going higher and higher with help from their friend, the Fed. This side believes that Dow 18,000 will be reached by January. Their strategy is buy and hold because everything is going to be all right with few hiccups.
The other side (the one I am on) is suspicious of this so-called bull market. Even if you ignore all the geopolitical problems, the market is telling us that all is not well underneath the surface. Of course the market can still go higher, but one day there will be a price to pay. In my opinion, that day is coming ever closer. The best advice is let the market have the final word (it always does). Although testing the market with small positions is recommended, it’s not the time to make extremely big plays (unless you are a confident speculator or brave).
Bottom line: Judging by the indicators and clues, it is impossible to predict which way the market will go this week. I am on the lookout for failed rallies.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.