All of the major indices have moved into a short-term “very overbought” state. More often than not, this type of reading signals a short-term reprieve in the market. There are still unclosed gaps from 2/1 and more recently 2/7. I would expect both gaps to close as we move towards the bearish portion of February – the second worst performing month for the market.
Another short-term bearish sign is Cisco’s (CSCO) horrible earnings report. The report led to a 15% decline in the stock this past week.
According to Jason Goepfert, “the last 3 Cisco earnings reports, each of which saw the stock get hit hard the next morning, also coincided pretty closely with the last three corrections in stocks in general (mid May, August and November). Over the 10 days following those reports, the S&P 500, at its worst point, lost -11.1%, -4.6% and -3.7%”.
As for last week, well, it was another glorious week for the bulls. Basically, I could just copy and paste the previous statement since the rally began back in September. The stock market has now advanced for five consecutive months, and the S&P 500 is up roughly 26% since September 1. The Dow moved to its highest level since June 2008. It has certainly been a remarkable run for the market.
Market optimism has also been increasing during this time. For 23 consecutive weeks, surveys by the American Association of Individual Investors [AAII] have shown a greater-than-average belief that stock prices will rise. The last time the surveys had such a long streak of bullish sentiment was in 2004 – in the middle of a 4 ½ year rally.
I really do not care if the market continues to rally over the intermediate to long-term. However, I do care about the short-term. Given the extreme readings in the ETFs I follow (check below) I would expect to see a short-term decline as we enter the early part of next week. This would certainly lead to another profitable trade in the strategy.
Short-Term High-Probability, Mean-Reversion Indicator – as of close 2/11/11
*Biotech (IBB) – 51.2 (neutral)
* Consumer Discretionary (XLY) – 88.1 (very overbought)
* Health Care (XLV) – 65.1 (neutral)
* Financial (XLF) – 76.4 (overbought)
* Energy (XLE) – 60.6 (neutral)
* Gold Miners (GDX) – 46.5 (neutral)
* Industrial (XLI) – 88.8 (very overbought)
* Materials (XLB) – 68.4 (neutral)
*Real Estate (IYR) – 81.3 (very overbought)
* Retail (RTH) – 71.5 (overbought)
* Semiconductor (SMH) – 77.0 (overbought)
* United States Oil Fund (USO) – 23.1 (oversold)
* Utilities (XLU) – 53.6 (neutral)
* Gold (GLD) – 53.5 (neutral)
* Small Cap Bear 3x (TZA) – 19.2 (very oversold)
* Small-Cap Bull 3x (TNA) – 80.1 (very overbought)
*UltraLong QQQQ (QLD) – 80.6 (very overbought)
* Ultra Long S&P 500 (SSO) – 80.2 (very overbought)
* Ultra Short S&P 500 (SDS) – 19.1 (very oversold)
* UltraShort 20+ Treasury (TBT) – 48.4 (neutral)
Disclosure: I am short DIA.