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 column for MarketWatch: http://goo.gl/90Fhgs
AAII survey (9/17/2014)
42.2% Bullish. 23% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (9/16/2014)
52.5% Bullish. 15.2% Bearish
Bearish: If sentiment is over 60% bullish.
Bullish: If sentiment is over 60% bearish.
VIX: 12.11 (on 9/19/2014)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
Moving Averages (daily): S&P 500 and Dow are above their 50-, 100-, and 200-day moving averages, and pointing up. Note: The Russell 2000 is below its 200-day moving average.
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 its zero line, and 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 61.99 (on 9/19/2014)
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 2.59% (on 9/19/2014)
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 remains elevated, especially the VIX, which is at historic lows. Most market participants do not believe this market is in any danger, which is reflected in the sentiment surveys. Although the Dow and Nasdaq are above their 50-, 100-, and 200-day moving averages, the Russell 2000 is below its 200-day moving average. In addition, 47% of the stocks in the Nasdaq Composite Index are down more than 20%, evidence that smaller cap stocks have been topping out for months. Finally, during the second quarter, “stock buybacks have fallen year-over-year for the first time since 2012,” says Barron’s. Stock buybacks have helped support this market. Bottom line: The Dow is making all-time highs while small caps are deteriorating.
Opinion: In my latest column for MarketWatch, which is coming out this week, I write how many long-time bears are capitulating. With the Dow making all-time highs, with the Fed willing to keep interest rates low for as long as possible, and with all bad news ignored, this market seems unstoppable. It’s not surprising that many bears have given up.
And yet, at market tops, the bears capitulate. Also, at market tops, bullish investors think they are geniuses (they confuse brains with a bull market), and some even write taunting emails or comments. I’ve received a few. As a result, I’m convinced this bull market is coming to an end sooner rather than later (but unfortunately I can’t predict when). I am well aware this is not popular as those with bearish opinions are at historic lows.
Although the market smells like a rose, inside there are very dangerous thorns. In addition to the extreme bullish sentiment, there is evidence the market is deteriorating. As mentioned above, the small caps are falling like dominos. Like the game of Three-Card Monte, while everyone is transfixed on the Dow, other stocks are selling off.
When you put all the clues together, you can see that this is going to end badly. Because of the Fed’s action, many investors believe this market “will never go down,” as I sarcastically wrote in a previous MarketWatch article. Little did I know how many people really believe it.
In addition to the capitulating bears, many bulls are making outlandish predictions. I have seen this before but in reverse. It was 2008 and the market was crashing. That was when bullish investors thought the market would never go up again. It was also when it seemed crazy to buy in the market as it continued to fall.
Here we are six years later and the positions are reversed. Now the herd is firmly on the side of the bulls, and some bears believe this market will never go down, so they are giving up. No one can predict the future but there are more than enough red flags around to tell me this is a dangerous market.
Could the market go up by another 5% and reach 18,000 by January? Yes, many people are convinced that is “certain” to happen, especially after author and professor Jeremy Seigel made that prediction. But in reality, no one knows what will happen.
I have a better suggestion: If you are long and have huge gains, consider taking money off the table. If you are bearish and believe the market is due for a fall, sit and wait. If you know how to manage risk and are willing to use stop losses, you can buy inverse ETFs (or buy put options). If the market keeps going higher, then set a predetermined target price to get out.
This I know for sure: Stock markets do not go up forever. I don’t know when but there always is a day of reckoning, and when that day occurs, the 90 percent bulls who are celebrating with their paper profits will be caught with their pants down. What if I’m wrong? If I’m wrong, then we’ll get to Dow 18,000 on strong volume. In addition, the Nasdaq and Russell 2000 will stop deteriorating, and will also make new highs. If that happens, I will be surprised, but anything is possible.
* Note: These signals are not actionable trades, but only guidelines. Always use other indicators, and your own research, to confirm before buying or selling.