I like to go through a few macro indicators that I use when faced with a sudden violent movement on the broad stock markets such as we are seeing at this time. Analysis of some proven macro indicators can give us added confidence in making trading decisions. Keep in mind that macro indicators are substantially different in nature than shorter termed timing signals. For example, you might get a bearish macro picture, but a temporary oversold buy signal from a series of short termed momentum studies such as Stochastics or RSI. The beauty of macro signals is that they are a true representation of crowd behavior. Macro work takes a look at forces operating on the entire market, or a broad market index like the S&P500. I find the macro indicators that I watch to be quite accurate, although usually leading market moves by a few months – as proven through my past calls where I referred to some of these tools:
Here are my “Heads up for getting out” blogs in March/April:
Here are my “Heads up for getting back in” blogs using the same indicators in late September/ early October:
Let’s see if the macro’s are telling us to hold, fold, or back up the truck n’ buy in the current selloff:
Smart Money/Dumb Money spread: neutral
I’ve covered this before so I won’t go into a detailed description on this indicator. Basically, this indicator, care of www.sentimentrader.com, shows us the spread between how bullish retail mutual fund buyers (dumb money) vs. institutional and other sophisticated traders (smart money). You want to follow the smart money, and fade the dumb money. As you will see on the chart below: the ratio of smart to dumb money confidence is literally around 0—nobody is overly optimistic or pessimistic. There is no edge to be seen on this indicator.
Put/Call ratio: neutral
Like the Smart/Dumb money indicator—this is a sentiment ratio. Too many traders hedging stocks with put options means too much pessimism. Too many traders loading up on calls means too much optimism for the future. The put/call ratio sits in the middle of its range right now. That’s a neutral situation.
New High/New Low NYSE: short termed oversold, longer termed bearish to neutral
Market breadth tells us the extend of participation by stocks in a rising market. This market breadth ratio can be used in two ways. It can be used to detect divergence in trends. If the market is going up, but its trending down, that’s bearish. The ratio must be smoothed with a moving average in order to do this. On the chart below that’s a 10 month MA – which is the blue line. Through the flat market—since late 2014, the New high/low 10 month MA has been heading down. That’s bearish.
The other way to interpret the new high/low ratio is to identify zones where it looks overbought over oversold. Too many stocks making new highs can be bearish. Everyone loves the market – that’s a bad thing. Too few stocks making new highs can be a sign of an oversold market. At some point, somebody is going to step in and buy the bargains if too many stocks are down. The current level of the new high/low ratio is reaching into oversold territory. You can see on the chart that its well below my lower zone line.
Interpretation: the 10 month MA on this ratio suggests a bearish to flat environment. The current level of the ratio itself suggests an oversold rally is due soon.
SPX Stocks over their 50 day MA: oversold
This indicator is often similar in direction to the new hi/low ratio discussed above. It can be interpreted in the same two ways. But I prefer just to look at the ratio itself – and look for overbought/ oversold situations. Right now its oversold. That’s a short termed bullish signal. I didn’t bother printing its chart given the similar interpretation to the new high/low chart.
Volatility Index (VIX)
The VIX tells us how much market participants are paying in option premiums. When they pay big bucks for their options – that’s a sign that volatility is high, and that everyone thinks that market volatility will continue into the future. As with any sentiment indicator – when “too many” traders think the same way – they are wrong. So I’ve arrived at a couple of zones that might indicate volatility extremes on the VIX. The upper band is a bullish signal, because traders are paying too much volatility premium on their options. The lower band is bearish—things are just too quiet out there when the VIX hangs out in the lower zone for too long. Right now – the VIX is in the middle of the two zones I use. No edge for market timing here.
My take on these signals
Given the generally neutral macro signals, I’m going to suggest there isn’t a lot of danger of a major crash, beyond a possible return to the summer lows. Nor is there much hope for a new up leg in the bull market past 2130 on the S&P500 at this time. Conditions are short termed oversold – thus, a bounce could be seen on the US markets pretty soon. To me, such a bounce suggests a selling opportunity. If the market remains as range bound as it has been over the past 14 months, I am inclined to trade these swings. Buy and hold investors will likely continue to be disappointed in their returns.
Where do you see resistance on the SPX? 1990 or 2040 where there is a gap?
S&P broke its double bottom neckline support yesterday. Now I am counting 3 days–to Monday’s close. So Tuesday is the earliest I would sell. If Tuesday rallies–i stay in. If not–out I go. Until then, resistance is assumed remaining at the mid to high 2000’s. But if it stays below 1990 by Mondays close, I have to assume that new resistance is 1990. Target then becomes August lows of 1870-ish. Wait n’ see. Follow your trading plan as unemotionally as possible. That’s what I try to do. It usually saves me from myself.
BTW–if I sell, then the market rallies back up through 1990–there is no shame in buying back in higher–we are better to follow the rules, even if you get a head-fake and lose a few %.
keith, it is very helpful when you provide these overall analysis. also appreciate that you did three this week-fitting the insecurity/volatility in the markets currently. it gives some expert opinion on direction, which helps with our personal choices in investing.
I enjoy reading the blog and it appears that I use similar rules to what you use. One area where I think my rules need work in deciding when to buy back after being stopped out. In your example above, if you were to sell and the market rallies above 1990, what would be your criteria for buy back ? Do you also wait X number of days above the resistance level or do you have additional criteria?
Yes Russ- I wait again for 3 days. Its a bugger if the market swings in small movements up and down, as it destroys you. Thats why you also need to leg in rather than fully commit on either side.
Hi Keith — this is great — thank you so much for taking the time to post it.
My position in spx is via VFV.TO. Am I thinking correctly that I should rely on the “real” chart (SPX) for indicators to then apply to VFV? (VFV adds the FX equation to the mix and the chart is “skewed.”)
Same FX complications are present when I try to chart XEF.TO (vs EAFE) and XEC.TO (vs IEMG).
Hope you have a good weekend.
Alex–yes, when you factor in the dollar, or dividends into price, it distorts the real picture. So I look at the SPX only –not an ETF with currency built in.
to clarify, when I wrote, regarding the SPX signals, “apply them to VFV.TO” — I mean buying or selling VFV based on SPX signals
Rather optimistic expectations. I would have thought that you would be using the 200 MA
I think that the only thing the indicators that I look at in this blog suggest is further sideways violent up/down moves. But no sign of a true bear market yet. That, of course, can most certainly change!!!
What do the charts show for the secular bull market. Is it over now. I believe you had mentioned on Market call that the technicals indicated a continuation for some time to come. If we are in a new bear market how long do they last? Hope to see you on Market Call soon.
Luca–a secular movement is usually one that lasts for a sustained period. For example–the 2001, 2008 crashes were secular, and lasted well over a year. I would say we are still in a secular bull market which should carry us until 2020+ BUT we are in a corrective wave within that secular bull. So far the corrective wave started late 2014 and has shown sideways movement since. The bull, IMO, will break out again –but not without a catalyst. That catalyst hasn’t appeared yet. So we should assume more sideways (big up / swings) pattern until proven otherwise.
Given these indicators, how would you trade the situation? would you be waiting for the bounce to begin before getting involved, or though I’m not a fan, would you find your trade now then average the cost down so that you don’t miss the rally? Given it will only be a short term oversold bounce most likely?
Thanks as usual,
I’m looking to sell in an oversold bounce, then will determine when I buy (or if I buy) back in thereafter. Lots of movement lately–too hard to be hard and fast with a trading plan.