Is It Time For This Bull To Take a Break?
A couple of conflicting Wall Street-isms seem to be weighing on traders currently.
The first is, "The trend is your friend." So far in 2013, the trend has indeed been kind to anyone holding long stock positions. As of yesterday's close, the S&P 500 sports a gain of 23.55 percent, which, if it finished here, would represent the second best year for the venerable index in the last fifteen years (for the record, 1998's gain of 26.67 percent is the only year to exceed 2013's return).
The bulls' current joyride to the upside has been especially painful for the bear camp, who came into 2013 expecting to have a field day. The bears had a long list of negative macro issues that they expected to come home to roost. There was the impact of the sequester, Europe's debt mess, the slowdown in China, and the assumption that the idiocy in D.C. would cause investors to head for the hills.
However, a funny thing happened on the way to the debacle... Nothing bad has transpired (yet?). And what's worse for the Negative-Nancy crowd is that investors started looking ahead to better days early in the year. So, before a bear could look up the definition of "the sequester," stocks were off to the races. And with the exception of a couple modest pullbacks, stocks haven't looked back since.
The State of the Market is Strong
To be sure, the state of the stock market is strong at the present time. Below is a quick run-down of the traditional market drivers (in no particular order):
- The Trend: With the market indices at or near all-time highs, by definition the short-, intermediate-, and long-term trends are all positive.
- Momentum: Market momentum too is in pretty good shape as the trend-and-breadth confirm indicators, the momentum models, as well as the volume models are all currently green.
- Earnings: Just about any way you measure it, the EPS for the S&P 500 is likely to finish at a record high. Sure, the growth rate could be better. But as long as earnings are growing, the bears may continue to struggle.
- Economy: The key to understanding how the economy impacts the stock market is to look ahead. Remember, the market is a discounting mechanism for the future and traditionally, stocks look ahead three to six months. So, with the economy still growing - albeit at a painstakingly slow pace - the bulls get the benefit of the doubt.
- Inflation: Although the recent dive in the dollar is sure to spark another bout of commodity inflation, the CPI levels remain low and contained. Advantage bulls.
- Interest Rates: There is little doubt that the trend of interest rates has been rising (although the yield on the 10-year has pulled back a bit in last couple of months) and will likely continue to do so for years to come. However, rates are rising from artificially low levels and are doing so for a good reason (improving economic conditions). Thus, unless rates move significantly higher - and in a big hurry - the interest rate environment will likely remain favorable for stocks.
- The Fed: Everyone on the planet knows the Fed will begin to taper their QE program at some point. However, Mr. Bernanke, Ms. Yellen et al have also gone out of their way to communicate that there will be "considerable amount of time" between the time the stimulus would stop and an actual rate-hike campaign would begin. So, for now at least, the phrase "Don't fight the Fed (especially when they are on a mission)" applies.
It should be noted that all of the above is merely a "quick and dirty" review of the key drivers to the stock market and is not meant to be an exhaustive analysis of the issues. The reason behind this exercise was to make the point that the stock market is in pretty good shape and is likely to stay that way for a while. But...
But... "Trees Don't Grow to the Sky"
The second key phrase investors may need to be reminded of is "trees don't grow to the sky." Put another way, the stock market doesn't move in a straight line. As such, traders and investors alike should recognize that it may soon be time for the bulls' current joyride to the upside to pause.
There are a couple of key exhibits to be offered up in favor this argument.
First and foremost, stocks are overbought from both a short- and intermediate-term time frame. While this in and of itself, is not a problem for the market, bad things tend to happen when both time frame cycles are aligned such as they are now. Thus, a technical set-up is in place.
Next is the sentiment indicators, which are now negative across the board. This tells investors that sentiment has reached an extreme and that conditions are now ripe for a selloff to take hold. In addition, a sentiment indicator with a solid long-term record gave a sell signal two weeks ago.
This is No Time to be Asleep at Wheel
In sum, the bulls are clearly on a roll at the present time and performance anxiety could easily drive prices higher into year-end. However, the number of reasons to be cautious at this stage continues to grow. Thus, the bottom line is a yellow warning light would appear to be flashing above the NYSE board at the present time.
However, to clarify, unless a new crisis arises, any corrective action in the near-term is likely to be short and shallow, and investors may want to consider buying the dip again.
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the Earnings Season
2. The State of Fed Policy
3. Overbought Condition
The State of the Trend
We believe it is important to analyze the market using multiple time-frames. We define short-term as 3 days to 3 weeks, intermediate-term as 3 weeks to 3 months, and long-term as 3 months or more. Below are our current ratings of the three primary trends:
Short-Term Trend: Positive
(Chart below is S&P 500 daily over past 1 month)
Intermediate-Term Trend: Positive
(Chart below is S&P 500 daily over past 6 months)
Long-Term Trend: Positive
(Chart below is S&P 500 daily over past 12 months)
Key Technical Areas:
Traders as well as computerized algorithms are generally keenly aware of the important technical levels on the charts from a short-term basis. Below are the levels we deem important to watch today:
- Near-Term Support Zone(s) for S&P 500: 1750
- Near-Term Resistance Zone(s): none
The State of the Tape
Momentum indicators are designed to tell us about the technical health of a trend - I.E. if there is any "oomph" behind the move. Below are a handful of our favorite indicators relating to the market's "mo"...
- Trend and Breadth Confirmation Indicator: Positive
- Price Thrust Indicator:Positive
- Volume Thrust Indicator:Neutral
- Breadth Thrust Indicator:Positive
- Bull/Bear Volume Relationship: Moderately Positive
- Technical Health of 100 Industry Groups: Positive
The Early Warning Indicators
Markets travel in cycles. Thus we must constantly be on the lookout for changes in the direction of the trend. Looking at market sentiment and the overbought/sold conditions can provide "early warning signs" that a trend change may be near.
- Overbought/Oversold Condition: The S&P 500 is overbought from a short-term perspective and is overbought from an intermediate-term point of view.
- Market Sentiment: Our primary sentiment model is Negative .
The State of the Market Environment
One of the keys to long-term success in the stock market is stay in tune with the market's "big picture" environment in terms of risk versus reward because different market environments require different investing strategies. To help us identify the current environment, we look to our longer-term State of the Markets Model. This model is designed to tell us when risk factors are high, low, or uncertain. In short, this longer-term oriented, weekly model tells us whether the odds favor the bulls, bears, or neither team.
Weekly State of the Market Model Reading: Positive
If you are looking for a disciplined, rules-based system to help guide your market exposure, check out The Daily Decision System.
Thought For The Day...
"Failure is the opportunity to begin again more intelligently" -- Henry Ford
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Wishing you green screens and all the best for a great day,
David D. Moenning
Founder and Chief Investment Strategist
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Positions in stocks mentioned: none
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