I like using a number of longer termed macro factors to determine the overall health of the stock market – combined with a number of shorter termed indicators that might help determine the potential for less serious moves that might occur within the coming days or weeks.
The big macro factors I look at include cumulative breadth (A/D line), cumulative moenyflow (Accumulation/Distribution line), weekly chart trends (highs and lows), sentiment, seasonality, VIX, and the 200 day Moving Average. The shorter termed factors I look at include momentum indicators, near-termed sentiment indicators like put/call ratio, near-termed breadth indicators like NYSE new hi/low and % stocks above their 50 day MA, and Bollinger bands (volatility).
Right now, a few of the short to mid termed indicators I watch are signalling the strong potential for a pullback. Take a look at the chart below. Note the divergence in trend vs. the momentum studies shown (Stochastics, RSI, MACD). They have been sloping down as the S&P has moved sideways. You’ll notice at the bottom of the chart that longer termed cumulative moenyflow is fine, but the Chalkin money flow oscillator on the top pane suggests shorter termed momentum for money flow into the market is failing. I wanted to keep the chart less confusing so I didn’t put Bollinger Bands on it – but I will note that the BB’s are “pinching” which tends to indicate a coming change in direction. I covered that observation on this blog.
On the chart below courtesy sentimentrader, note the extremely low confidence of Smart Money (commercial hedgers, etc) – in contrast to the bullishness of Dumb money (Retail investors). Not shown are a few other sentiment studies I follow (too many to post). These include the confidence of Advisors in the market (most Investment Advisors are less sophisticated than the public might perceive…), and the Risk Appetite Index (ratio of money entering or leaving “risk on” vs. “risk off” assets). Both of these are in the “danger zone” – that is, too many advisors like the market, and too much risk is being taken by investors. Finally, sentimentrader notes that short interest on the widely traded SPY ETF is 24% below its 3 year historic average, and has recently hit a similar low level last seen in June 2007. Nobody thinks this market has downside.
Normal seasonal tendencies are for markets to get a bit choppy from mid January in through much of February- you can see where I’ve circled the upcoming period on the equityclock chart below.
As noted in past blogs, markets have shown a tendency to peak by or around inauguration date. Given valuations and the above technical factors, I’d suggest we’re in for a short termed pullback into and possibly through much of February. Sectors that tend to peak at this time of the year include technology and biotechnology, which are groups contained in the broader based NASDAQ, plus homebuilding and silver. The bigger picture remains largely bullish (my main macro concern being the ongoing low VIX level), but it might not be a bad idea to lower your exposure – should you have it, to these sectors in light of the potential near-termed market risk. Raising cash from these groups might afford you the opportunity to buy into more seasonally attractive sectors in the coming month or so.