How fast is too fast? The S&P continues its move upward since toe-tapping 1398 back on New Years Eve day. While retail investors, financial advisors, mutual funds, pensions, and banks may be scrambling to move money into equities, providing a huge "put" for the market, the fact remains that the recent move up has not had a "breather." But that alone is not necessarily a reason to short the market. After all, the sayings go that "the market can remain irrational longer than you can remain solvent" and "you should never short a quiet market." The adage about not shorting a quiet market doesn't mention taking advantage of the low implied volatility in options to at-least hedge yourself. Consider the following:
RSI on the S&P is quite high. A 14-period RSI on the daily S&P is currently reading over 85. That alone does not provide the answer to the question of whether we pull back. In late January and early February of 2012, the 14-period RSI for the S&P reached 80+ and the S&P "worked the number off" by moving sideways. This could happen if new funds are pushed into equities. Let's look at other factors to find out more clues.
The iShares High Yield Bond ETF (NYSEARCA:JNK) tracks corporate high yield bonds ("junk bonds") and moves when the market is in a "risk on" mood. It is currently above it's 13 day exponential moving average, which I use as one trend-measuring tool. Therefore the trend remains up, but a close below could signal a pullback.
The TICK index, which measures stocks trading on an uptick versus stocks trading on a downtick, can be used as a contrarian intra-day indicator. Thresholds for an oversold TICK level very but -1000 wouldn't be an uncommon level to consider buying for a reversal. We haven't seen a -1000 TICK level in weeks. You could read that as meaning that we haven't had an extremely oversold intraday market in that time. That isn't bearish on its own, but it is a pretty long time for no large negative TICKs.
The CBOE Equity-only Put/Call Ratio is at .68 which indicates far more calls than puts are being purchased. This is often used as a contrarian signal because retail investors tend to get overly bullish with calls at the least opportune time. The problem is that it has been at these levels for many days now, so what's a few more days,, or weeks?
The iShares 20 year bond ETF (NYSEARCA:TLT) generally moves inversely to equities. The bonds are also considered "smart money," sometimes more accurately predicting future overall market moves. Now we may have something. TLT did close above its 13 day exponential moving average today. This could be a signal, but alone it isn't enough.
The SPX advance/decline line is very strong -- over 4500. I mention this to show that while the market may be overheated in the near term, it is unlikely that we are near a longer term top. Tops tend to see fewer and fewer stocks carrying the market to new highs. Therefore I would expect a pullback to be bought, whether at 1450, 1430, or 1400 support levels.
Overall, the market has been strong, likely because of: 1) huge inflows from fixed income and cash, and 2) the lack of uncertainty that has haunted investors the past two years. While the market looks temporarily overheated, there does not appear to be a bear market around the corner. It may however be prudent to hedge your portfolio, especially considering the lack of volatility priced into index options -- ie. cheapness of puts. The movement of funds into equities could itself be considered a sort of contrarian indicator, especially if it was clear that it was mostly the retail investors doing it. But it appears a lot of groups may be playing catch up, so there may be significant legs left, at least until the Federal Reserve's real intentions become clear regarding rates.
My play: I'm looking to buy cheap SPY puts as a hedge; and I'll possible buy some Feb 140/143/146 SPY Butterflies if I can get them for .20 or less. I almost certainly won't be holding them until expiration.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in SPY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.