Each weekend, I study market behavior using sentiment and technical indicators. My goal is to use clues, observation, and indicators to analyze underlying market conditions. If you can determine the current market environment and trend, it may help you to create profitable trading strategies.
RELEASED: Understanding Options (McGraw-Hill, 2E), Understanding Stocks (McGraw-Hill, 2E), Start Day Trading Now (Adams Media), and Predict the Next Bull or Bear Market and Win (Adams Media): http://bit.ly/1bl0ZNk
My latest MarketWatch column (Aug 14): http://goo.gl/Axc5Pi
AAII survey (8/19/2015)
26.8% Bullish. 39.8% Neutral. 33.3% Bearish.
Bearish: If sentiment is over 50% bullish.
Bullish: If sentiment is over 50% bearish.
Investors Intelligence (8/18/2015)
37.7% Bullish. 18.4% Bearish.
Bearish: If sentiment is over 60% bullish. (Note: Percent of bears is still at historic lows. 13.3 % is the 1987 low.)
Bullish: If sentiment is over 60% bearish.
VIX: 28.22 (on 8/21/2015)
Bearish: Less than or near 12.
Bullish: Greater than or near 40.
RSI (S&P 500): RSI is at 24.84 (on 8/21/2015)
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.
Moving Averages (daily): The S&P 500 is below its 50-, 100-, and 200-day moving averages, and pointing down.
Bearish (Short-term Downtrend): Index crosses under 50-day, 100-day, 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 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 zero line. MACD line crosses above 9-day signal line.
Bonds: U.S. 10-year yield is at 2.05% (on 8/21/2015).
Note: 3.0% or higher is significant (consider selling bond funds as yield rises). 3.5% or higher and risk increases (for bondholders).
Analysis: You already know from the headlines that the Dow had its worst week in four years, that it has fallen more than 10% from its high, which is a correction, and that all the indexes fell well below their 200-day moving averages. All of the leading stocks sold off. In addition, the S&P 500 fell below key technical levels including 2080, 2030, and now 2000, which caused major technical damage. Did you see the VIX? It had the highest one-day spike in its history, from the low 12s to 28. At least for a few days, fear crept into the market. Another change was that RSI fell to under 30, which means the market is technically oversold. Therefore, the odds are good there will be a bounce this week, perhaps Monday or Tuesday. On the sentiment side, surveys were conducted earlier in the week so it did not reflect the selloff. I assume that retail investors are feeling more vulnerable now, although there isn’t panic (yet). One of the most important developments was all the market leaders rolled over last week. The leaders had been holding the indexes up, but last week investors sold them off viciously. Bottom line: The long anticipated correction arrived with a bang. This will be a very difficult market environment to manage and many investors, including many pros, are going to get hurt.
Opinion: I can sum up the market in two words: “It’s complicated.” Fortunately, I won’t spend one second discussing “why” the market plunged; I’ll leave that to the pundits. But I do have a lot to say about this dangerous market. Today’s blog will be longer than usual.
A few weeks ago, I said that a major trend change, or pivot point, seemed to be developing. Last week gave us more clues that the bull market may be stalling. There is one more major clue we are waiting for, and here it is: Based on the oversold RSI and market history, the odds are good there will a bounce this week. It could come as early as Monday afternoon (after the margin calls are completed), or Tuesday.
This is exactly what Wall Street wants, and they should get their way. Nervous investors will sigh with relief that the 10% correction is out of the way. And after the bounce, it will get very, very interesting.
If and if
If the S&P bounces strongly but does not go back to its previous highs eventually (2000, 2030, and 2080), that would be a negative sign. Yes, the chances are good there will be a rally, but what happens next is the key.
If the indexes rally and can retake its previous highs, then the bull market will continue for a while longer. If, however, the rally fails (or if there is a weak rally), and the market keeps falling, Wall Street will scream at the Fed to do something to save the market.
What will the Fed do?
Allow me to speculate what the Fed might do based on probabilities: At first, the Fed may do nothing. If the market bounces without outside help, the Fed may stay quiet, as long as the market is relatively calm. If the Fed acted responsibly, it would proceed with a quarter point interest rate hike in September or December, and leave the markets alone. However, based on past Fed actions and pressure from Wall Street and financial pundits such as Jim Cramer and Suze Orman, the odds are high the Fed will delay raising interest rates this year. In addition, if the market keeps plunging, the pressure will be intense to initiate a QE4 style program with a new name. In other words, the Fed will feel obligated to do something to stop the carnage rather than leave the markets alone. Because of the Fed’s expected interference with words and actions, the indexes will be volatile, so be ready for anything.
Although the market may settle down for a few days or weeks, danger is percolating below the surface. Most important, be very careful about listening to advice. You are going to hear a lot of conflicting opinions. Think about this: Only a week ago most pundits were telling investors to buy AOT (any old thing), and that any pullback was a “buying opportunity.” By the way, many are repeating that advice:
“We are advising clients to stay invested and use the drop in stock prices as an opportunity to add quality stocks at lower prices if they need equities in their portfolio.” Edward Jones strategist
“We are advocating clients to stay invested, if not add to positions.” TCW strategist
Most of the major Wall Street firms are giving the same advice: Buy on pullbacks and buy on rallies. In other words, buy but don’t sell. Why? Because this strategy has worked in the past.
Here’s a minority view: “I’ve been bearish for months and expect a sharper pullback. We are in the early stages of a broader selloff and we expect a double-digit correction before we bounce back.” Ed Shill, chief investment officer at QCI Asset Management.
Wall Street and most of its followers will be spreading this message: “Stay the course. This was a natural 10% correction so stay calm. Do not panic or make any impulsive decisions.”
Think and Plan
The next few weeks will be fascinating. As mentioned earlier, I suspect that we have reached a pivot point. If I’m right, then the market will let you know. No one, not even the Fed, is bigger than the market, so if this market is destined to go down, it will eventually no matter what the Fed throws at it.
Bottom line: This is the time to pay full attention to the market. Fortunes can be made or lost if this is truly a trend change, but it won’t be easy. Very few want this market to fall, and with the Fed’s help, the damage may be contained temporarily. We will soon find out soon enough who will win the week. Based on past history, the bulls are desperate for a strong rally, and they will likely get it.
Additional note to speculators: Be careful about stepping into this market too soon. Let the market confirm your opinion before making any big plays. For those willing to buy puts (or short), there will be opportunities over the next few weeks and months.