Regular readers know that I have been bullish in the last couple of weeks in anticipation of a relief rally (see Get set for the relief rally and The sun will come out tomorrow). However, I have been less certain about the course of the market once the relief rally runs its course. For now, I am giving the bull case the benefit of the doubt, but a number of indicators are troubling me.
Wait for the O'Neill follow through
First and foremost, we have not seen an O'Neil follow-through day after the market trauma caused by the budget debate of the past couple of weeks. Here is how the system pioneered by William O'Neil works:
- Day 1 is the day of the rally off the bottom. In this case, that occurred on October 10.
- Wait until Day 4.
- A "follow-through day" is a day when the market rises 1.5% or more on higher volume than the previous day.
- Follow-through days that occur after day 7 indicate weak rallies.
O'Neil says that while follow-through days can give off false signals, no sustained rally has occurred without a follow-through day. Wednesday, (Oct. 16), which was Day 4, almost qualified, but no major average achieved a gain of more than 1.4%. It's not quite time to throw in the towel yet, but I would like to see signs of positive momentum in the stock market before Tuesday, which could be volatile because of the scheduled September jobs report.
Sentiment getting bullish
As well, my expectation of a relief rally has been the consensus call and the AAII survey shows an alarming number of bulls (via Bespoke):
Macro outlook stalling?
More troubling is the loss of momentum shown by the Citigroup U.S. economic surprise index, which measures whether high-frequency economic releases are beating or missing expectations, is starting to keel over. While the level remains positive, indicating more beats than misses, the loss of momentum is a concern.
The strength of the American economy has been the consumer, but the economic recovery has been incredibly uneven as much of the gains have accrued to the top income earners. This effect can be seen in the relative performance of Tiffany (TIF) against Wal-Mart (WMT). The chart below shows the TIF/WMT ratio (in black) and the SPX (in orange). A rising ratio has been correlated with a rising stock market. The ratio recently saw a minor violation of its relative uptrend, but it could be a blip related to uncertainties over the government shutdown.
Is it time to sell the news? Not yet, but my inner trader is keeping stops tight and watching my bearish tripwires very, very carefully:
- Earnings outlook: How is Earning Seasons progressing?
- Macro outlook: Any signs of a slowdown?
- Monetary policy: How easy is the Fed?
My most recent post addressing these topics (see The sun will come out tomorrow) ranked the earnings outlook as neutral, macro outlook as neutral and monetary policy as bullish. However, the latest data points are pushing the macro outlook negatively and my inner trader, cautiously bullish, is getting increasingly nervous.
Disclaimer: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui's blog to ensure it is connected with Mr. Hui's obligation to deal fairly, honestly and in good faith with the blog's readers."
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