Rare Sell Signal Flashes Warning On S&P

Includes: SPY
by: Market Analyst

Rare Sell Signal Flashes Big Warning on S&P

With the major indices up 10-15% year to date, and up close to 40% over the past year-and-a-half, many have been looking for reasons for a pullback in recent months. So far, these bearish calls have been absolutely wrong, but a rare sell signal will be triggered this month in the S&P. The indicator I'm referring to is called the demark indicator, which identifies potential exhaustion points after an extended run in either direction. This tool has been used with varying degrees of success on both individual stocks and indices, but the track record with the S&P when the 'setup' indicator reaches a 9 on a monthly time frame is very strong*. Similar setups are developing on both the Dow and the Russell 2000, but cannot trigger until May. The last opportunity I got to highlight this particular sell signal was in May of 2011, just as the markets were topping before a 20%, 5-month decline.

Over the last 15 years, there have only been 6 other times we've seen this monthly demark 9 sell setup, and while not all of them occurred right at a top, they all resulted in either steep declines or prolonged periods of consolidation. Not one of them was able to hold on to any further significant gains over 3-6 months.

Going back even further, we find the only major failures from this signal occurred in the late-80s and mid-90s, with equities continuing 10-20% higher after 3 of the signals. However, even in those cases, nearly all the gains were given back within a year or two before the market launched higher.

And from the mid-60s through the early-80s, the majority of the signals occurred within a few months of the start of major corrections. Three of these were major bear markets, with the Dow and S&P dropping 30-50%.

Taken together, the nearly 20 signals over the last 5 decades have resulted on average is a decline over the first month, and essentially a flat market over 3- and 6-month time frames, with a third of the signals marking the start of full-fledged bear markets. Add to this the problems of peak margins, weakening global economy, extended valuations, and the already well known 'Sell in May' seasonality, and we have a recipe for a repeat of 2011. The risk-reward no longer favors the bulls, and now is the time to take profits.

*This is not the most standard way of using the demark indicators, but in practice I've found weekly and monthly setup 9's on the S&P (both perfected and not perfected) to be very useful. The demark 'setup' consists of the green numbers if you're using the indicator on Bloomberg. The setup is complete when it reaches 9. There is another portion of demark called the 'countdown', which is a major element of the indicator (and is also signaling a '13' sell now), but the focus of this article is just on the monthly setup 9.

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.

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