Four Indicators for When to Exit the Rally 18 comments
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I published a post a few days ago on the issue of whether stock markets were in a secondary (i.e. cyclical bull) or primary bull market.
I quoted a research project by Ned Davis (Ned Davis Research) in which he identified seven dimensions one could use to compare the March 9 low with secular lows of the past. The research showed that only one of the seven criteria indicated a secular bull was in place, whereas three were neutral and three were bearish. Although Davis believed the nascent rally had more upside potential, he concluded, like Richard Russell, that we were dealing with an extended rally (cyclical bull phase) within a secular bear market.
Davis has now turned his focus to what criteria would signal that one should exit the rally. His yardsticks were reported by Mark Hulbert on MarketWatch and are as follows:
(1) Valuation. Davis would look to exit from stocks whenever the P/E ratio on the S&P 500’s normalized earnings reaches 20. Putting this indicator into practice is a bit tricky, since it requires normalizing those earnings - adjusting them, in other words, for where we are in the economic cycle. Nevertheless, Davis calculates that normalized earnings on the S&P 500 Index currently stand at “around $60″, which suggests Davis will be looking to start exiting the market at the 1,200 level.
(2) Sentiment. Davis maintains his own sentiment index, which he calls his “Crowd Sentiment Poll”. This index currently stands at 62% according to Davis, which is just above the 61.5% level he considers to be the lower bound of “extreme optimism”. He says that on past occasions when this index rose above 61.5%, its eventual peak has averaged 68%. He says reaching that level this time around would “be a sign for traders to begin selling weak performers”.
(3) Internal market divergences. The indicator that Davis relies on here is one created three decades ago by Norman Fosback, who currently edits a newsletter called Fosback’s Fund Forecaster. The indicator is called the “High Low Logic Index”, which represents the lesser of new 52-week highs or new 52-week lows as a percentage of all issues traded. Fortunately for the current market, this index is solidly in bullish territory right now at 0.8%, according to Davis’ calculations. He says it would have to rise to around 2.5% before he would start looking for the exit signs.
(4) Rising interest rates. Davis has found from his research that one of the best market-timing indicators in recent years has been the 26-week rate of change for investment-grade bond yields. With that rate of change currently standing at minus 12.6%, a sell signal from this indicator is not imminent.
Davis concludes that only one of these four indicators is even close to flashing a sell signal and he therefore gives the bull the benefit of the doubt (but in a secular bear market).
I find it difficult to pinpoint a top in a momentum-type market as we are experiencing now, but am concerned about the fact that the S&P 500 is now priced for 40% earnings growth and 4.0% real GDP in the coming year (as calculated by David Rosenberg of Gluskin Sheff & Associates). Looking at the next few weeks, I see no reason to alter my assessment as stated a few days ago:
I am of the opinion that stock markets have run away from fundamental reality and that a pullback/consolidation looks likely. Taking a slightly longer-term view, I think we are in a (possibly lengthy) bottoming-out phase as far as slow-growth (OECD) countries are concerned, but already in new (potentially volatile) uptrends regarding high-growth emerging and commodities-related markets.
In the short term, caution seems to be in order.
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I will give you another indicator. I am a conservative active investor. I know it is going to correct, and I am thinking of getting in. When I do, short the market!
Remember the old joke about the gambler who, when told the card game was crooked still played, because it was the only game in town.
I consider 8% to be "tight," and I am using that level to reflect the fact that this is a late-recession rally in anticipation of the end of the recession. That means that the rally is not (yet) supported by strong underlying fundamentals. It is sentiment-driven, meaning that as long as the "net news flow" is somewhat positive (i.e., supporting the view that the economy is getting better), the rally will probably continue.
enigmaman...your analogy made me smile.....very nice!
Secondly, Nasdaq has recently moved above it's 80-Weeks Mvg. Avg. (Currently around 1948.50). Historically, this is the level where the bull markets have started or the bear markets have peaked. If Nasdaq can manage to stay around it's 80-Weeks Mvg. Avg. for the next few weeks, odds favor start of a bull market. On the flip side, if the leading index (Nasdaq) breaks this important level to the downside decisively, chances of the end of bear market rally increase tremendously.
Since July 23, both $SPX and DOW have advanced in a narrow upward-slanting flag pattern with potentially bearish implications. Thus, the overall picture does not favor bulls!
On Aug 11 09:04 AM Old Trader wrote:
> So we haven't yet reached the point where everybody realizes the
> green shoots are Triffids, to use a cult sci-fi movie reference...
>
>
> enigmaman...your analogy made me smile.....very nice!
Of course, my assumption pre-supposes that a) growth of sales actually begins to occur in the companies that have had a downward spiral, and b) the absence of any real politically activity is a plus, and after the August break is over, Congress will still not embark on any radically new tactics to "help" their fellow Americans
And, as for unpredictable trigger events like ampsucker points out, the point is they are unpredictable and you can't forecast them.
And this is very healthy for markets life.
Jorge Taboada
1. Goes up on bad news from MSFT, AMZN, AXP's poor numbers results few weeks ago.
2. The investment gurus and analysts who got blind sided by last fall's fall and March low (boy weren't they pessimistic) are now in unison as bullish as ever, even with heck of a run since March.
3. Bears are hiding and appear to be capitulating on short covering. One can say the bears were "early" smart money.
4. Russell 2k has been on a tear. Speculation galore or halcyon days are back?
5. CNBC has special on Dow 9k and Cramer is pounding the table with buys and the lemming retail and professional investors are piling in. So much for the lows we had in Oct/Nov and March.
6. And even Barron's sounding bullish sans Abelson?
7. Historically Sept is the worst month followed by Oct. Just around the corner.
8. Low volume on recent rally in last month or so despite program trading. Volume proceeds price. Lack of volume on follow-thru to S&P 1k and Nas 2k portend downside ahead.
9. Lowry’s Buying Power Index nudges record 1933 low. Few breadth studies are as insightful as those provided by Lowry Research since 1931.
"The key to Lowry’s is not the absolute level of its Buying Power Index. It’s the relationship between Buying Power and Selling Pressure. The span between declining Buying Power and rising Selling Pressure hit a 78-year record distance of 807 on July 8. The wider the span, the more bearish the situation.”
10. Very heavy insider selling. Insider selling to buying is 4.16 to 1 in July compared to 0.76 to 1 in March.
Takeway?
My 2-cents is that we'll see 50% retracement to March low in Sept/Oct.
I'd have my stops trailing a bit longer than a day and a half's volatility, which now stands at 3%. Recent past sell-offs have been like turning off a switch; they chart a waterfall, nearly vertical drops. And be CAUTIOUS: if the downward tick skips your stop, you may be very unpleasantly surprised when you learn your order was not executed and the market is far below your exit strategy point. OOPS!
Form follows function: the market's function is to separate the outsider from his money for the benefit of the insider. Simple. No?
On Aug 11 04:29 PM puravidavid@yahoo.com wrote:
> There is one indicator that is always reliable: wave form. Form follows
> function and it has always been 5 steps forward, 2 steps back, at
> every degree of scale, and by fractals governed by Fibonacci retracements.
>
>
> I'd have my stops trailing a bit longer than a day and a half's volatility,
> which now stands at 3%. Recent past sell-offs have been like turning
> off a switch; they chart a waterfall, nearly vertical drops. And
> be CAUTIOUS: if the downward tick skips your stop, you may be very
> unpleasantly surprised when you learn your order was not executed
> and the market is far below your exit strategy point. OOPS!
>
> Form follows function: the market's function is to separate the outsider
> from his money for the benefit of the insider. Simple. No?
Analysts falling all over themselves to upgrade companies.
Analysts have more buy ratings out there than the previous 36 months (and they certainly cannot be because of companies earnings since we all know companies are bringing in less revenue than anytime over the past 3 decades)
The major houses (ie: GS) are dragging out the big guns (Abby Jackass Cohen) in an attempt to get mom and pop Americans really deep into a very extended rally, so the IB's can unload to them.
Major "strategists" (i like to use the words "lying clowns") are now out in full force raising estimates for the S & P targets, and worse outright lying about how much money S & P companies are going to earn over the next few quarters.
I know, I am a pathetic broken record, but I will say it again:
Mom and Pop Americans:
Buy stocks when no one wants them. Buy them when Wall Street is telling you to sell. Buy them when Wall Street is begging you to take your money out of the market and give it to them claiming only they can invest it. Buy stocks when CNBC is telling you to sell. Buy them when Cramer et al start telling you to sell (not take money off the table buy sell) just like they did at S & P 680.
For heavens sake take control of your money and your mind, and get these criminals out of your head once and for all!!!
compdivplan.com
As a matter of fact, Doug Kass posted a summary of his "bearishness" yesterday (see link below). Is it just me or is this guy all over the place?
consequencesunintended...
Today, both $SPX and DOW broke down from their respective upward-slanting narrow channel (flag) with estimated minimum price target of 880 and 7400 respectively.