Before I get to the new Bear-o-meter reading, I thought I’d post an interesting chart created by Jason Castelli, Technical Analyst with Raymond James. For the record, Jason notes that he didn’t re-capitalize the index (a feat that would be cumbersome, and likely inaccurate even if attempted). As Jason notes:
While the chart is not a perfect representation (based on price rather than market cap weighted) it does speak to how the breadth of the rally has been narrowing, which is something I highlighted in prior emails. The S&P 500 price level less AMZN in the top panel looks considerably different that the actual S&P 500 in the lower. This chart is for illustration purposes as it places a heavier importance on AMZN than actually exists in the broader market.
I post this chart because it ties into some of the observations I made when running through the Bear-o-meter compilation. Market breadth, or participation, is one of those factors. I’ll be visiting the subject of breath below. Jason’s re-worked SPX chart shows us that broad participation in this rally looks weak if you remove AMZN, even if the chart isn’t entirely accurate.
As a refresher (you don’t need to read this if you follow this blog regularly):
The Bear-o-meter is a risk/ reward indicator. It’s a compilation of 12 indicators falling under 6 general classifications:
- Breadth: This is an indication of the market’s “conviction” – it measures things like the movement of the Dow Industrial stocks vs. the Dow Transports, and the cumulative number of advancing stocks vs. declining stocks on an index. More participants in a move, be it up or down, means more conviction by market participants in that move.
- Trend: Moving averages tend to indicate how strong a trend is, depending if the market is above or below the given moving average. The longer the moving average, the more significant that average is in determining the strength of the trend.
- Breadth momentum: Sometimes, when too many stocks are moving up or down too vigorously, we have a problem. Breadth momentum looks at things like the total number of stocks making new highs vs. new lows, and the number of stocks above or below their moving averages. If they go over or under certain numbers, we get overbought/oversold indications. I find breadth momentum more telling of forward looking risk than standard momentum indicators like RSI and ROC- which simply focus on overall index price moves. That’s because breadth momentum shows the internal convictions of the markets by examining the individual participation of a move more closely.
- Sentiment: Sentiment looks at fear and greed. Its a contrarian indicator. Too much bullishness is bad. Too much fear is good. I’m looking for extreme ends of those two market attitudes. A good sentiment indicator like the VIX or the put/call ratio can give us a heads-up of irrational exuberance or despondency by market participants.
- Seasonality: Season studies were first conducted by Yale Hirsch, founder of the Stock Traders Almanac. Canadian analysts Brooke Thackray and Don Vialoux took up the gauntlet for seasonal studies here in Canada. All of these analysts have proven the statistical relevance of reducing equity exposure in the summer months and re-entering the market in the fall. It doesn’t work every year. But, it works well enough to be a factor in the Bear-o-meter.
- Valuation: As a Technical Analyst, I try not to spend too much time examining market valuations. However, one indicator remains a reasonably good longer termed indicator of relative market value. That’s be the good old PE ratio on the S&P 500. Too high, and its an extended market. Too low, its undervalued. The problem with the pE ratio is that its really not a good timing factor. Markets can remain overvalued for extended periods of time. But, its still a factor that should be noted, as valuations will at some point regress to their longer termed mean average. Hence, I use it as one factor in the Bear-o-meter.
Where the Bear-o-meter stands today
As many of my regular readers know, the Bear-o-meter assigns risk on a scale of 0-8. A reading of 3 or under is generally a higher risk market. A reading of 3-5 is about “average” for a risk/reward trade-off. Anything 5+ is considered lower than average risk. Last month’s reading came in a t a very neutral level of “4”. Risk and reward were about even. Most measurements of the Bear-o-meter fall into this neutral zone (Star Trek reference unintended). The current reading of the Bear-o-meter is “1”. This suggests the market presents a less attractive risk/reward trade-off at this time.
Hate to say it, but you’ve got bad breadth
Beyond seasonality, the big loss of Bear-o-meter points came in from market breadth. As noted on Jason Castelli’s chart above, the market’s rally since the March low point has been on a pretty narrow group of stocks. This can be seen in the percentage of stocks in the S&P 500 over their important moving averages. While the % over their 50 day SMA did rise from an oversold level of only 5% last month to 58% this month – the number of stocks over their 200 day SMA’s remains below 25% within the index.
New high/New low ratio shows a break even number of stocks making new high vs. those making new lows. This is another indication that not all ships are rising with the tide, as is said.
The most distressing of the indicators was the Industrial stocks (INDU) vs. Transportation stocks (TRAN) reading. This comparison comes from Dow Theory, which states that these two averages should confirm each other. While we don’t have outright divergence, we do have a vastly under performing transportation sector compared to the industrial sector. The chart below illustrates this discrepancy. Transports are the black line–note the monstrous decline vs the industrial line, in red.
15 Comments
Hi Keith,
Thanks for all the info you provide. The market is being elevated by a few mega-cap tech names and the IBB. So I like that your BOM (bear o meter) is giving your a reading of 1. So how much of a decline do you see coming if things do indeed roll over?
Thanks,
Parm
Parm–it seems that the SPX is struggling around the 2900 point – it may hang out here or even get to the 200 day SMA before making a negative move. Downside? Hard to call, but perhaps 2600-2700 zone makes sense.
If we got a second COVID breakout after “opening up the economy again”–we may see a poop-storm. But that is just me thinking out loud. For now, the most likely situation is a 10% pullback + or – a bit.
Thank you Keith for keeping us informed under these difficult times .
From your comments above , I assume it’s time to sell SHOP?
Stay well and I will try to join your webinar today . I met you in Orlando in February.
Carlo Rea
Hi Carlo
I may be back to do the Orlando show again this winter. Hope to see you there!
I normally don’t like to talk individual stocks on this blog–lest I get peppered with everyone’s questions regarding their own individual stocks. SHOP is a big one though, so I’ll answer in the spirit of it being a well followed position that others who read this might hold.
We like SHOP–but yes, its way overbought. It will pull back. But the overall technical breakout is positive.
Seems like indicators like rsi and stochastics are not near the overbought levels. Seems like market is in a middle of the road indecision time waiting for the opening of the economy
Keith: Thanks so much for your insights, and help. Do I remember a few blogs ago, that you were selling your gold positions due to being overbought? Did you do it? I have held on to my gold producers for now, and they are again, going gangbusters. Is it time to sell into this?
Hi Tom
Yes we sold (doh!). It just goes to show you that overbought can get more so. I do think the sector is getting very ahead of itsef – was just doing the MneyShow talk and somebody asked me about the sector–I pointed out the overbought momentum signals.
I’d like your confirmation that should the bear-o-meter prove true that the risk is higher than the reward today, and if the market corrects further over the period that companies like Amazon in the US and the TSX leader in the north being Shopify might not be able to buck the market trend and will also fall from their high. I note that in the April/March correction that Amzn fell 24% before going back to new highs. Shopify dropped ~32%. My point being even these two market beheamoths expectedly should correct somewhat if the markets correct.
Thanks
Well, lets assume the market does pull back in the next couple of months (I do make that assumption–but acknowledge that nobody can make too many prognostications with huge confidence these days)
If that happens, there is always the “all ships rise and fall with the tide” idea
My thoughts are that a 10% pullback (which is what I imagine might make sense)- you might still see the defensive stuff have less downside –like AMZN, WMT, utilities, some staples, etc – although overbought stocks like SHOP might be hurt more.
Thanks for the link to the webinar today. Your presentation was excellent!
you liked it Arlyne–we will try another one in a couple of weeks – although not a MoneyShow presentation–might give me a bit more time to field questions.
There are a ton of stocks with that same formation as Pembina pipelines just waiting to break higher. Ie DIS Disney. ENb, Enbridge. Could be some nice trades in the next few weeks. They like you say likely won’t take out pre covid highs but no need to for some nice gains
Yes, we have been “value” picking lately. Small consolidations, with a minor breakout might indicate upside.
Two questions-
How will perpetual preferreds do if there are negative interest rates?
and
LifeCos are suffering because of low interest rates. Why are they happy paying 4.5-5.0% on $25 par
Hi Keith- Any theory on this?
Lifecos are suffering because of low interest rates.
Why do lifecos like MFC SLF GWO and POW pay 4.5%-5.0 on the $25 par value to keep their perpetual preferred shares alive? They could retire these shares if they wanted to.
They are yielding 6% on the current market price. Again, if they legally can, why would they not buy up these shares at market value?
Thanks
Randy
Perpetuals at a fixed dividend will theoretically benefit from falling rates (assuming the companies cashflow can maintain the dividend), but any floating pref’s will suffer in negative rates.
Re: why they keep these pref’s out there–some will have redemption clauses, but some may not. I guess you’d have to read the offering papers to know – we don’t hold any pref’s at this time. Craig (who does the fundamental analysis here at VT, and does most of the decisions on our Income Platform) feels they are risky right now. That’s about all I can offer to your questions.