The latest signals of each model are as follows:
- Ultimate market timing model: Buy equities
- Trend Model signal: Bullish
- Trading model: Bearish
Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
Subscribers can access the latest signal in real-time here.
Not what you see at market bottoms
I have been writing about the extended nature of sentiment for several weeks. Macro Charts
highlighted an email from Interactive Brokers on how to build a “balanced” portfolio using fractional shares, consisting of Netflix, Tesla, Alphabet, and Amazon. Either someone forgot the basics of financial planning in constructing a balanced portfolio, or we are back to the go-go days of the dot-com and Nifty Fifty bubbles.
While it is true that sentiment models are less effective at calling tops than bottoms, there are sufficient signs that investors and traders should be reducing equity risk and taking some chips off the table.
Momentum rolls over
While it is true that bullish sentiment can remain elevated for quite some time, a useful rule of thumb is to wait for downside breaks in technical indicators before turning cautious. Recently, the NYSE McClellan Summation Index (NYSI) rolled over from an overbought extreme, indicating a loss of momentum. Most of these episodes have resolved with market stalls (red vertical lines) while only a small minority have seen the market continue to advance (blue lines).
A bad breadth warning
An analysis of relative performance of the top five sectors of the S&P 500 also reveals the headwinds the index is facing. These sectors comprise over 75% of index weight, and the market would have difficulty rising without the participation of a majority of these sectors. Currently, only the smallest of the top five, financials, is displaying positive relative strength. All of the other sectors are either trading sideways or falling relative to the S&P 500.
Negative RSI divergences
In addition, negative RSI divergences are showing up in market leaders even as they make new relative highs. Since the March low, small cap stocks have been on fire, but the relative performance of the Russell 2000 to S&P 500 is exhibiting an RSI negative divergence even as the ratio makes new highs.
The enthusiasm for the ARK Innovation ETF (ARKK) is highly reminiscent of the mania surrounding the Janus 20 Fund during the dot com era. Similar to the Russell 2000, the ARKK to SPY ratio is also exhibiting a negative RSI divergence, which is another warning for the bulls.
Lastly, you can tell the character of a market based on how it reacts to news. The S&P 500 broke short-term support (shaded box) even as Biden unveiled a $1.9 trillion fiscal support package, and Fed chairman Jerome Powell reiterated the Fed’s dovish commitment to maintain the pace of asset purchases. In addition, earnings beats by Citigroup and JPMorgan were met with red ink for their share prices. These reactions are indicative of a heavy tape and a market that’s ready to fall. In the short-term, the path of least resistance is down. Primary support can be found at the rising trend line at about 3750, with secondary support at the Fibonacci retracement levels of 3588 and 3515.
Also keep an eye on the USD. The USD Index is undergoing a counter-trend rally by rising through a short-term downtrend (dotted line), but the long-term downtrend (solid line) remains intact. Initial resistance can be found at about 91, with key secondary resistance at 92. The USD is an important risk appetite indicator. It has been inversely correlated with both the S&P 500 and emerging markets (bottom panel).
In conclusion, the seasonal Santa Claus rally that began in December is living on borrowed time. This market is vulnerable to a 5-10% setback, and it can correct at any time. While it’s impossible to call the exact timing of a short-term top, the weight of the evidence suggests that it’s time to tactically reduce equity risk and take some chips off the table. We are into a period of negative seasonality and choppiness until early March.
Subscribers received an email alert that my inner trader had initiated a short position in the S&P 500. Keep in mind, however, that the primary trend is still bullish, and the utility of trading short positions in a bull market is less useful.
My inner investor remains overweight equities. He has selectively sold covered call options against long positions as a way of reducing risk.
Disclosure: Long SPXU