Mid-week technical update: I wrote on the weekend that I expect that the stock market would continue to rise on an intermediate term basis, but some short-term weakness was likely (see A repeat of the failed Oct/Nov rally of 2015?). What I did not expect was to see a short-term buy signal after the brief weakness that we saw today (Wednesday).
In retrospect, it was easy to see that a pullback was coming. This hourly chart of the SPX shows negative divergences on RSI-5 and RSI-14, which set up the conditions for the fall in prices.
Intermediate-term bullish
On the other hand, the longer term outlook remained bullish as sentiment indicators were supportive of a move higher. Chris Prybal of Schaeffer`s Research highlighted analysis by his colleague Rocky White that short interest, which is reported monthly, continues to rise. This is a contrarian bullish reading on an intermediate term basis.
In addition, Brett Steenbarger made a couple of bullish observations. First, he believes that the current rally is not a “bounce in a bear market”:
My cycle measure continues in elevated territory, again unlike much of what we saw in 2015, where strength led to weakness. That continued elevation on a shorter-term cycle measure suggests that a longer-term cycle is at play and that this has been more than a bounce in a bear market.
In addition, he noted that shares outstanding for SPY was falling even as the market rose, which indicates that the traders are skeptical of the rally and therefore the market is climbing a wall of worry:
I also notice that shares outstanding for the SPY ETF have once again dipped, now dropping below their levels from 5, 10, and 20 days ago. Very interestingly, the number of shares outstanding for SPY has dropped over the course of the rally from mid-February. Share redemption has generally been associated with superior returns over a multi-week horizon.
An uncertain buy signal
As the market sold off today, what alerted me to a possible bullish signal was the continued negative sentiment prevalent in the market. First of all, TRIN spiked over 2, which can be an indication of panicked selling, which is unusual given the shallowness of the pullback.
Elevated levels of TRIN can be an imperfect buy indicator. The chart below shows past instances when TRIN was above 2.
In addition, the ISE equity-only call/put ratio, which measures customer-only opening option transactions, stayed low all day near the 100% level, which is contrarian bullish for a day when prices are weak.
My inner trader isn’t totally convinced that this represents THE BOTTOM on a short-term basis, but he stepped off the sidelines at the market close to buy a small initial long SPX position.
Disclosure: Long SPXL
Hey, find your own fishing spot!! I’m already here!!!
Thanks Cam, good luck.
OTH, Dana Lyons showed that when 1-Month VIX / 3-Month VXV = 78% or lower, S&P lower by a median -3.7% 3 months later. Over the last two days, VIX/VXV has been 78% or lower.
March 12-20, 2012 – The S&P 500 chopped sideways for a few weeks before falling some 9% over the next 2 months
August 13-22, 2012 – The S&P 500 chopped sideways for a few weeks before rallying by as much as some 4% over the next few weeks. 2 months later, the index had lost that entire gain, and another 4%.
December 5, 2014 – The S&P 500 immediately dropped 5% over the next 2 weeks before chopping sideways for several months.
March 20, 2015 – The S&P 500 dropped 2.5% over the next week before moving sideways for several months.
Yes, I saw that. But also see this analysis from Mark Newton indicating that we are seeing a powerful breadth upswing. The leadership change that I referenced on the weekend is holding & sentiment is supportive of further gains:
http://realmoney.thestreet.com/articles/03/23/2016/3-batteries-are-charging-energizer-bunny-rally
Also see these stats from Ryan Detrick:
https://twitter.com/RyanDetrick/status/712815779385839621
Given this background, my inner trader thought it was totally appropriate to go from 100% to a partial long position. My best guess of downside risk is around 2% from these levels = favorable risk-reward.
A couple of observations for intermediate and trading investor types from long experience. Whenever a new bull market cycle begins (and I believe we have started one January 20), most investors stay in a bear market mentality for 9 months to a year. When stocks rally and then pull back, the retreat is much less than they expect. This is what Cam is highlighting today. This is because so many investors see the recent extreme bargain prices at the lows and vow to buy if the stocks get down there again. Unbeknownst to them most of the reasons stocks hit their low are no longer there (China collapsing, Fed raising rates, Euro bank crash, commodity crash or whatever). But because so many are thinking the same way to load up, the wall of buyers prevents a decline back to those easy entry points. The stocks mark a higher low and move to a higher recovery high quickly.
Traders who short with the previous bear market successful attitude get caught on the wrong side of the new uptrend. Smart ones realize something new is happening. Losers try to find new reasons why the world will end and keep on losing.
Long term investors can also make mistakes. Many have been praying during the bear for a rally to lighten up and sleep better so they put in stop losses (the method they should have been using at the top of the market not at the bottom) or other loss-prevention techniques. When they get stopped out (or called away on a covered write), the pullback is just about over and stocks march to new highs without them. They might do stop buys to get back in but this leads to the first year or two of a bull market getting stopped out and then stopped back in so many times the investor is dizzy and losing most of the benefit of the market uptrend.
Knowledgeable, successful investors who spot a new trend when markets make a higher low and then break out to a new higher high, will switch to bull market mode and become believers in whatever the bullish camp is saying and making money doing. This time it could be value stocks, gold, commodities and industrials. The leaders will show themselves. It pays to listen to their stories.
The big question as to what type of market we are in will be answered soon if this pullback stops well short of the recent bottom and then breaks out to a new recovery high or not. If it does, my clients will smile.
Any significance if one of the reasons stocks hit their low — Fed raising rates in April or June — is now maybe, sort of, back on the table?