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.